Sunday, July 31, 2011

Debt Ceiling Legislation Has No Revenue Raisers, But Sets Up Joint Congressional Committee to Draft Legislation on Deficit Reduction

While the final legislation raising the debt ceiling will not contain any revenue raisers such a carried interests provisions affecting asset managers, it is highly likely that it will establish a bi-partisan Joint Select Committee of Congress charged with drafting legislation to reduce the deficit under expedited procedures providing for an up or down vote by the end of the year. Senator John Kerry (D-MA) analogized the process endorsed by the legislation as similar to the military Base Realignment and Closure Commission.

There is a distinct possibility that the Joint Select Committee’s draft legislation will include elements of tax reform similar to the so-called grand bargain between the Administration and House Speaker John Boehner (R-OH) that ultimately fell apart. This scenario, which is by no means certain but may appear more probable as the members of the committee are appointed, could address tax reform issues around carried interest, LIFO accounting, off-shore tax havens and the is misalignment of the federal rax code and financial accounting standards that can have a profound impact on company financial statements filed with the SEC

A blueprint of the final legislation establishing the Joint Select Committee may be gleaned from the Budget Control Act, S 637, which passed the House on July 29, 2011. The Joint Select Committee would be composed of six Senators and six Represenatives, evenly divided by party, appointed by House and Senate leaders. The Committee Co-Chairs would be appointed by Senate Majority Leader Harry Reid (D.NV) and House Speaker John Boehner (R-OH).

By November 23, 2011, the Joint Select Committee must vote on a report containing a detailed statement of the findings and recommendations of the Committee, with legislative language to carry out the recommendations. The report and the proposed legislative language requires the approval of a majority of the Committee.
The Select Joint Committee must, by December 2, 2011, submit its report and the legislative language to the President, the Vice President, the Speaker of the House, and the Majority and Minority Leaders of both Houses. The must also promptly make the full report and legislative language, and a record of the vote, available to the public.

In performing its duties, the Select Joint Committee may hold hearings, require attendance of witnesses and the production of documents, take testimony, receive evidence, and administer such oaths the Committee considers advisable.
The legislation provides for an expedited Congressional consideration of the legislation recommended by the Joint Select Committee. The proposed legislation must be introduced in the Senate on the next day on which the Senate is in session by the Majority Leader or his designee and, similarly, must be introduced in the House of Representatives on the next legislative day by the House Majority Leader or his designee.

Any committee of the House or Senate to which the Select Joint Committee bill is referred must report it to the House or Senate floor without amendment by December 9, 2011. The House and Senate must vote on the Committee’s proposed legislation by December 23, 2011 and no amendments will be permitted.

Friday, July 29, 2011

Securities Industry Asks DOL to Coordinate with SEC on Redefining ERISA Fiduciary

The securities industry wants the Department of Labor to coordinate with the SEC regarding a proposal to redefine the term “fiduciary” under the Employee Retirement Income Security Act (ERISA), effectively changing 35 years of established regulatory certainty. In testimony before the House Education & Workforce Committee, SIFMA executive vice president for public policy and advocacy Ken Bentsen said that the DOL proposal should be withdrawn and reproposed and that necessary exemptions must be promulgated in advance of any final rule. Mr. Bentsen said that the proposed regulation has far broader impact than the problems it seeks to address. It would reverse 35 years of case law, enforcement policy and the understanding of plans and plan service providers as well as the manner in which products and services are provided to plans, plan participants and IRA account holders, without any legislative direction.

SIFMA asserted that the proposed rule is in conflict with Section 913 of the Dodd-Frank Act, which authorizes the SEC to establish a uniform fiduciary standard of care for brokers and advisors providing personalized investment advice. While current exemptions to the prohibited transaction rules of ERISA permit fiduciaries to select themselves or an affiliate to effect agency trades for a commission, there is no exemption that permits a fiduciary to sell a fixed income security or any other asset on a principal basis to a fiduciary account. Lack of exemptive relief in this area is contrary to what Congress explicitly stated in authorizing the SEC to promulgate a uniform fiduciary standard of care for brokers and advisers providing personalized investment advice under Section 913 of Dodd-Frank. In SIFMA’s view, the result of that conflicting prohibition is that the broker would not be able to execute a customer’s order from his or her own inventory, but rather must purchase the order from another dealer, adding on a mark-up charged by the selling dealer.

That mark-up would result in an added cost for these self-directed accounts, noted SIFMA. and would disproportionately fall on smaller investors, such as small plans and IRAs Of even more concern, it would eliminate the most obvious buyer when a plan wants to sell a difficult to see security. Further, given that the rule would eliminate a clear understanding when a broker is acting as a fiduciary, and thus increase liability risk, it is likely that brokers will transform such accounts into asset-based fee arrangements or wrap accounts so the brokers can comply with the prohibited transaction rules that govern fiduciaries under ERISA and the federal tax code.

ERISA expressly states that a person paid to provide investment advice with respect to assets of a private-sector employee benefit plan is a plan fiduciary. The Internal Revenue Code has the same provision regarding investment advisers to IRAs. ERISA and the tax code prohibit both employee benefit plan and IRA fiduciaries from engaging in a variety of transactions, including self-dealing unless the relevant transaction is authorized by an exemption contained in law or issued administratively by DOL.

On October 22, 2010, the DOL published a proposed regulation defining when a person is considered to be a “fiduciary” by reason of giving investment advice for a fee with respect to assets of an employee benefit plan or IRA. The proposal amends the current 1975 regulation that may inappropriately limit the circumstances that give rise to fiduciary status on the part of the investment adviser. According to testimony by Assistant Secretary of Labor Phyllis Borzi, the proposed rule takes into account significant changes in both the financial industry and the expectations of plan fiduciaries, participants and IRA holders who receive investment advice. In particular, it is designed to protect participants from conflicts of interest and self-dealing by correcting some of the current rule's more problematic limitations and providing a clearer understanding of when persons providing such advice are subject to ERISA's fiduciary standards, and to protect IRA holders from self-dealing by investment advisers.

At the hearings, SIFMA also noted that, during consideration of the Dodd-Frank Act, Congress considered the question of a counterparty providing a fiduciary duty to plans engaging in swaps and it rejected such an approach because it wanted to be sure that plans could continue to engage in such activities principally for hedging purposes. However, as currently drafted, the Department’s proposed rule would result in a counterparty being deemed a fiduciary, which would eliminate the ability for plans to enter into swap transactions.

The SEC and CFTC were directed by Congress to establish business conduct rules for dealers engaging in swaps with plans, and the Department’s rule would conflict with those rules. SIFMA noted that DOL has not fully considered the costs of this proposal on small plans and IRAs and the manner in which their investment choices will be curtailed, or the costs on large plans that may be unable to engage in swaps, prime broker their assets, invest in alternatives, obtain futures execution and otherwise have their investment choices limited by the proposal.

Kansas Adopts Domestic Issuer Exemption

A domestic issuer exemption was adopted by the Kansas Office of the Securities Commissioner, effective August 12, 2011, along with updates to federal securities statutory and rule references.

An issuer’s offer or sale of a security is exempt from registration, advertising filing and issuer-agent licensing, provided:

(1) the issuer is a Kansas-organized business;

(2) the transaction complies with the federal intrastate offering exemption at Section 3(a)(11) of the Securities Act of 1933;

(3) the total amount of cash (and other consideration) received from all securities sales in reliance on the exemption does not exceed $1 million, less the aggregate amount received for all securities sales by the issuer within the 12 months before the first offer or sale under the exemption occurs;

(4) the issuer does not accept more than $1,000 from any single purchaser unless the purchaser is an "accredited investor" as defined under Rule 501 of SEC Regulation D;

(5) a commission (or other remuneration) is not paid or given, directory or indirectly, to any person representing the issuer in the offer or sale unless the person is a Kansas-registered broker-dealer or agent;

(6) funds received from investors are deposited in a Kansas-authorized bank; funds must be used in accordance with investor instructions;

(7) the issuer notifies the Commissioner in writing of the transaction before using general solicitation or before the 25th sale of the security, whichever event occurs first, and indicates the offering is being conducted in reliance on the exemption; the notice contains the name and address of the issuer, the persons representing the issuer in the offer or sale, and the bank where the funds will be deposited;

(8) the issuer is not an "investment company" as defined in Section 3 of the Investment Company Act of 1940 and subject to reporting requirements under Section 13(d) or 13(e) of the Securities Exchange Act of 1934, either before or as a result of the offering; and

(9) the issuer informs purchasers that the securities were not registered under the Kansas Uniform Securities and, therefore, may not be resold unless they are registered or qualify for an available Kansas exemption.

NOTES: The exemption may not be used in conjunction with any other exemption under the Kansas regulations except for offers and sales to controlling persons of the issuer. The exemption is not available if the issuer is subject to one of the specified "bad boy" disqualification provisions in the accredited investor exemption rule.

In Letter to Senate Banking Committee Leaders, CEOs Support Cordray Nomination as CFPB Director

Against the backdrop of news reports that the Senate Banking Committee will hold hearings next week on Richard Cordray’s nomination to be the first Director of the CFPB, the CEOs of three major US companies expressed strong support for the Cordray nomination. In a letter to Committee Chair Tim Johnson (D-SD) and Ranking Member Richard Shelby (R-ALA, the CEOs said that they have worked with Mr. Cordray during his career in Ohio, and have the highest regard for his ability to partner and collaborate on the most important issues facing the business community. As a County Treasurer, State Treasurer and State Attorney General, they noted, he has been the epitome of the judicious and fair-minded public servant. He has impressed the CEOs with his intelligence, pragmatism, integrity, and service-oriented mindset. The letter was signed by Michael G. Morris, Chairman and CEO, American Electric Power, John E. Pepper Jr. Retired Chairman and CEO Procter & Gamble and Leslie H. Wexner Chairman and CEO Limited Brands.

Thursday, July 28, 2011

CFPB Official Tells Congress Bureau Will Help Small Businesses Not Burden Them

A senior CFPB official told a House panel that, although the CFPB’s jurisdiction over small business lending is very limited, the Bureau can able to help small business borrowers in three ways. First, CFPB efforts to prevent unlawful discrimination should promote a fairer marketplace and thereby promote credit availability. Second, the Bureau will provide the market with better data on small business lending. Third, the Bureau may be able to help consumers who rely on their personal credit histories when they apply for a business loan.

In testimony before a House Small Business subcommittee, Dan Sokolov, Deputy Associate Director, Division of Research, Markets & Regulations, noted that the Bureau does not have jurisdiction over small business credit except in limited cases where Congress has explicitly and affirmatively granted the Bureau such jurisdiction. The main exception is the Bureau’s authority to prevent discrimination in business lending. The CFPB official also noted that the Bureau may be able to help many potential small business borrowers with better lending data and more accurate consumer credit histories.

He also pointed out that, under the Regulatory Flexibility Act (RFA), the CFPB must conduct a regulatory flexibility analysis unless it can certify that a proposed regulation will not have a significant economic impact on a substantial number of small entities. In these analyses, explained the senior official, the Bureau will consider the effectiveness and compliance burdens of a proposal versus less burdensome alternatives. Section 1100G of the Dodd-Frank Act amends the RFA to provide that the analysis must describe any projected increase in the cost of credit for small businesses, and significant alternatives in that light, and the CFPB will act accordingly.

The Bureau official also said that the CFPB will seek public input on benefits and costs even before it proposes a rule. The Bureau’s project to reform mortgage disclosures has engaged and will continue to engage extensively with lenders about how to reduce compliance burdens, well before proposing a regulation. The CFPB will also follow the requirements of the Small Business Regulatory Enforcement Fairness Act (SBREFA). Generally, unless the Bureau can certify that a proposed rule will not have a significant economic impact on a substantial number of small entities, the Bureau will seek input directly from small entities about potential costs and potentially less-burdensome alternatives even before proposing the rule.

Exceptions to the consumer laws’ focus on consumer financial services are few, explicit, and well-defined, he said, and they also provide significant benefits to small businesses. The Equal Credit Opportunity Act (ECOA) prohibits lenders from discriminating in the provision of business and consumer credit on the basis of race, national origin, sex, or other protected bases. The Bureau implements ECOA by regulation and supervises compliance with ECOA for certain lenders.

The Dodd-Frank Act helps small businesses by filling a major gap in knowledge about the market for small business credit. Section 1071 of the Act amends the Equal Credit Opportunity Act to require that financial institutions collect and report information concerning credit applications made by small businesses and women- or minority-owned businesses. One stated purpose of Section 1071 is to strengthen fair lending oversight. The CFPB and other authorities will be able to use these data to improve the effectiveness and efficiency of fair lending enforcement efforts.

New business lending data will also improve understanding of both demand conditions and supply conditions. Reporting this data publicly, as the Act requires, may tend to make the small business credit market more transparent and efficient. The CFPB official said that the Bureau will move deliberately and with substantial public input to maximize the benefit of these loan data for small businesses and to minimize the cost for their lenders. To develop implementing regulations, the Bureau will engage the small business community, business lenders, and civil rights and community development groups.

Small financial institutions, which frequently make both consumer loans and business loans, are often burdened disproportionately by compliance requirements, as compared to larger institutions. The Bureau is working to reduce existing regulatory burdens where feasible and to avoid imposing unwarranted new regulations, emphasized the Deputy Assistant Director.

The official also assured that the Bureau will consider the potential benefits and costs of proposed rules to consumers and covered persons, including small lenders. The Bureau will consider specifically impacts on banks and credit unions with assets of $10 billion or less described in Section 1026 of the Act.

Georgia Provides Broker-Dealer/Agent Application Requirement Checklist

A checklist of application requirements for persons applying to register as broker-dealers or agents in Georgia is provided.

Federal Judge Rules on Investor Federal Securities Claims Against Outside Auditor of Lehman Financial Statements

The September 2008 collapse of Lehman Brothers Holdings Inc. disrupted the entire economy and greatly affected owners of the company’s securities. A federal judge ruled that investors failed to state a claim that the company’s outside auditor violated Section 11 of the Securities Act and also failed to state a claim that the auditor misrepresented compliance with generally accepted auditing standards. But investors did sufficiently allege that the outside auditor made a false or misleading statement in Lehman’s 2Q08 in that it professed ignorance of facts warranting material modifications to Lehman’s balance sheet when in truth it had received information concerning Lehman’s use of Repo 105s temporarily to move $50 billion of inventory off that balance sheet, information that cast into doubt the balance sheet’s consistency with GAAP. (In re Lehman Brothers Securities and ERISA Litigation, 09 MD 2017, SD NY, July 27, 2011).

This case concerns more than $31 billion in Lehman debt and equity securities issued pursuant to a May 30, 2006 shelf registration statement, a base prospectus of the same date, and various prospectus, product, and pricing supplements, which incorporated by reference several of Lehman’s SEC filings. Investors who purchased some of these securities brought a federal securities action against Lehman’s former officers, directors, and auditors, as well as underwriters of the securities, under Rule 10b-5 and Sections 11 of the Securities Act.

The allegation is that Lehman’s offering materials were false and misleading because they incorporated by reference Lehman’s financial statements, which in turn contained misleading statements and omissions concerning Lehman’s use of “Repo 105 transactions and their effect on Lehman’s reported net leverage, risk management policies, liquidity risk and concentrations of credit risk.

The investors alleged that the outside auditor’s statements in Lehman’s 2007 10-K concerning its audit and Lehman’s financial statements, and (2) Lehman’s quarterly reports on Form 10-Q for the second and third quarters of 2007 and the first two quarters of 2008 concerning its review of Lehman’s financials were materially false and misleading. The investors alleged misstatements with regard to compliance with generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP).

The investors also claimed that the auditor violated requirements of due professional care and professional skepticism by ignoring or failing to respond adequately to three red flags: namely 1) Lehman’s inability to obtain from a U.S.-based law firm a true sale opinion regarding Lehman’s accounting treatment of Repo 105s, (2) a netting grid that identified and described the Repo 105s, and (3) the auditors June 12, 2008 interview with the senior vice president in charge of Lehman’s Global Balance Sheet and Legal Entity Accounting

The court found that Lehman’s use of a true sale at law opinion letter from a U.K.-based law firm was not a red flag for two reasons. First, given that the US legal system sprung from the English one, it would be odd to conclude that the use of an opinion from a well known U.K.-based law firm on a question of common law calls into question the accuracy of the opinion’s conclusion. Second, and more importantly, the letter is not said to have provided the auditor any indication that Lehman improperly increased its use of the Repo 105 transactions at the end of each reporting period because the opinion that a Repo 105 involved a true sale did not address the issue that is pertinent here. The opinion went only to the question whether the Repo 105s were properly accounted for as sales under FASB strandards and not the question of whether the financial statements
nevertheless were misleading because the manner in which the Repo 105s were used presented a deceptive picture as to Lehman’s net leverage.

Nor was the netting grid a red flag that Lehman used the Repo 105 transactions at the end of each quarter to manipulate its reported net leverage ratio. The netting grid disclosed the volumes of Repo 105 transactions on Lehman’s balance sheet on November 30, 2006, and February 28, 2007, but did not disclose to E&Y when these transactions were entered into or that they were unwound promptly after the end of each reporting period. The grid therefore could not have alerted the auditor to the possibility that Lehman was using these transactions to manipulate its net leverage and overall financial position at the close of each reporting period.

The executive interview, but for its timing, would have been different. The executive allegedly told the auditor that Lehman had used Repo 105 transactions to remove temporarily $50 billion from its balance sheet at the end of the second quarter of 2008. Although Lehman’s audit committee allegedly had instructed the auditor to report to it any allegations of financial improprieties, the auditor allegedly failed to relay the senior officer’s concerns or investigate them itself.

In these circumstances, said the court, and bearing in mind that the issue might appear differently on a fuller record, a trier of fact reasonably might find that the auditor knew by June 2008, when it interviewed the officer, that the Repo 105s may have been used to manipulate the balance sheet, at least at the end of the second quarter of that year. Had the auditor subsequently issued a clean audit opinion, knowing that it had not followed up appropriately on the executive’s allegations, that opinion could well have been false. But the only audit opinion at issue here was the one the auditor expressed with respect to its 2007 audit and that appeared in the 2007 10-K, issued on January 28, 2008.

The court noted that the firm’s GAAS opinion, just like those rendered by all or substantially all accounting firms, is explicitly labeled as just that, an opinion that the audit complied with these broadly stated standards. More is necessary to make out a claim that the statement of opinion was false than a quarrel with whether these standards have been satisfied.

The court also noted that the auditor’s statement regarding GAAS compliance inherently was one of opinion. In order for the investors sufficiently to have alleged that it was false, they had to allege facts that, if true, would permit a conclusion that the auditor either did not in fact hold that opinion or knew that it had no reasonable basis for it

The standard for evaluating assertions of an auditor’s scienter is demanding, said the court, because it must be alleged that the auditor’s conduct was highly unreasonable, representing an extreme departure from the standards of ordinary care and approximating an actual intent to aid in the fraud being perpetrated by the audited company. The accounting judgments which were made must have been such that no reasonable accountant would have made the same decisions if confronted with the same facts.

The investor’s allegations respecting red flags therefore bear not only on whether the firm violated the pertinent GAAS requirements, but also on whether it did so with the requisite state of mind. The true sale opinion and netting grid were not red flags, the disregard of which could be called highly reckless. And, while the auditor’s alleged failure to follow up on the executive interview arguably would have been a departure from GAAS, the only subsequent E&Y statement at issue is the report on the interim financials in the 2Q08, which contained no statement of a GAAS-compliant audit. Accordingly, the investors failed to allege that the outside auditor made any false or misleading statements with respect to GAAS compliance either in the 2007 10-K or in any of the subsequent 10-Q’s, ruled the court, much less that it did so with scienter.

The investors also alleged that the auditor’s opinions as to Lehman’s preparation of its financial statements in accordance with GAAP were statements of fact and that they were false because those financial statements in fact did not comply with GAAP.

The only alleged departure from GAAP relates to Lehman’s use of Repo 105s and the only such departure that the court found sufficient was the claim that Lehman’s use of such transactions at each quarter-end to reduce its net leverage temporarily resulted in the financial statements portraying the company’s leverage in a misleading way, this notwithstanding that the investors did not sufficiently allege that the accounting treatment of those transactions, in and of itself, was inconsistent with GAAP.

Since there was no claim that the auditor did not in fact hold the opinion that it expressed with respect to Lehman’s compliance with GAAP, the question is whether investors sufficiently alleged that E&Y had no reasonable basis for believing that Lehman’s financial statements were prepared in accordance with GAAP. In other words, did they sufficiently allege that the auditor knew enough about Lehman’s use of Repo 105s to window-dress its period-end balance sheets to permit a finding that E&Y had no reasonable basis for believing that those balance sheets fairly presented the financial condition of Lehman.

The investors relied for this purpose on precisely the same alleged red flags discussed previously in connection with the auditor’s GAAS opinion. The true sale opinion and the netting grid were no stronger in this context than in that, said the court, but the executive interview was a different matter.

The investors said that the senior officer told the auditor in June 2008 that Lehman moved $50 billion of inventory off its balance sheet at quarter-end through Repo 105 transactions and that these assets returned to the balance sheet about a week later. Assuming that is so, said the court, the auditor arguably was on notice by June 2008 that Lehman had used Repo 105s to portray its net leverage more favorably than
its financial position warranted, a circumstance that could well have resulted in the published balance sheet for that quarter being inconsistent with GAAP’s overall requirement of fair presentation. Thus, the court found that the investors adequately alleged that the auditor misrepresented in the 2Q08 that it was not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. GAAP, notwithstanding the executive’s disclosure to it.

Turning to the Securities Act claims against the auditor, which were based on the same statements regarding GAAS and GAAP compliance as the Exchange Act claims, the court noted that accounting firms are subject to Securities Act Section 11 liability only if the alleged misstatement or omission occurs in a portion of a registration statement, or a report or valuation used in connection with the registration statement, prepared or certified by it.

SEC rules provide that a report on an unaudited interim financial statement by an independent accountant must not be considered a part of a registration statement prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Section 11. Thus, misstatements or omissions in a report on unaudited interim financial information cannot give rise to accountant liability under Section 11(a)(4). Since the outside auditor made the only otherwise actionable statements in reports on unaudited interim financial information, the Securities Act claims against it failed.

Wednesday, July 27, 2011

Raj Date to Replace Prof. Warren as Treasury Special Advisor on the CFPB

The Department of the Treasury announced that, effective August 1, 2011, Raj Date will replace Professor Elizabeth Warren as Special Advisor to the Secretary of the Treasury on the Consumer Financial Protection Bureau (CFPB). After a successful tenure standing up the CFPB, noted Treasury, Professor Warren will return to her position as the Leo Gottlieb Professor of Law at Harvard Law School. Mr. Date will lead the CFPB’s day-to-day operations and help continue the important work begun under Professor Warren’s leadership.

Raj Date currently serves as Associate Director of Research, Markets, & Regulations at the CFPB. He oversees several offices, including Research, Regulations, Card Markets, Mortgage Markets, Credit Information Markets, Deposit Markets, and Specialty Finance Markets.

House Leaders Note EU Rating Reform Efforts as Comm. Barnier Launches Broad Reforms

Against the backdrop of recent remarks on credit rating agency reforms by EU Commissioner for the Internal Market Michel Barnier, hearings before a House panel emphasized the need for international coordination and harmonization of reform efforts. The House Oversight and Investigations subcommittee heard testimony from SEC, Fed and OCC officials around efforts to comply with Section 939A of the Dodd-Frank Act, which directs the SEC, along with all other federal agencies, to remove references to credit ratings from their rules and forms and to substitute such alternative standards of creditworthiness as the Commission and the others determine to be appropriate. John Ramsay, Deputy Director of the SEC’s Division of Trading and Markets said that in each case the SEC’s goal is to reduce undue reliance on credit ratings and to encourage independent assessments of creditworthiness.

Subcommittee Chair Randy Neugebauer (R-TX) said that the debt ceiling negotiations and the long-term fiscal health of the U.S. have brought a renewed focus on the credit rating agencies. On the one hand, the Dodd-Frank Act attempts to de-emphasize the role of credit rating agencies in federal regulations and, on the other hand, the Act further entrenches the government-sponsored oligopoly of the big three credit rating agencies. The former approach to reduce reliance on credit rating agencies enjoys widespread bipartisan support, the Chair noted.

Chairman Neugebauer asked if the agencies have published standards of creditworthiness. The regulators described the effort as tricky and complicated. One challenge is around bank capital rules, and there is complexity because bank capital rules are inter-agency, and are also negotiated internationally and international accords contain credit references. Chairman Neugebauer likes the interagency approach, the approach needs to be standardized. He emphasized that the US cannot talk about Basel accord harmonization and other international coordination efforts until it has its own coordinated plan.

Financial Services Committee Chair Spencer Bachus (R-ALA) noted that the European Union is making great efforts to end their reliance on rating agencies. He referred to recent remarks by EU Commissioner for the Internal Market Michel Barnier that the Commission has as a top priority addressing reliance on credit ratings. Commissioner Barnier said that credit ratings are too embedded in legislation and that he intends to reduce as much as possible the references made to those ratings in prudential rules. Chairman Bachus urged the SEC, OCC and Fed to coordinate with the European Commission’s efforts.

Commissioner Barnier is working on an initiative to address over reliance on credit ratings. He said that the Commission wants credit ratings to be considered simply as one view among other views. According to Commissioner Barnier, this is an issue of financial stability, as well as an issue of political responsibility and democracy. The Commission can neither justify nor accept that private companies have such power over populations.

The first measure to limit overreliance will be integrated into the upcoming modification of the Capital Requirements Directive, he noted, which is the effective translation of Basel III into EU law. To limit overreliance, the Commission will strengthen the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way. Before the year end, the Commission will also make other concrete proposals to limit overreliance to deal with the insurance, asset management and investment fund sectors.

The issue of rating agency civil liability to investors will also be addressed. Commissioner Barnier noted that European regulation could allow for investors to take agencies to court when there has been negligence or violation of applicable rules. While there are already rules relating to civil liability in some member states, he acknowledged, a European framework would allow for a more coherent application of rules and might help to make financial actors more responsible.

Globally, there is the issue of the rating of sovereign debt, which plays a crucial role not only for the rated countries but for all countries, since a downgrading has the immediate effect of making a country's borrowing more expensive, makes states weaker, and there are possible effects of contagion on neighboring economies. Commissioner Barnier believes that regulators should be more demanding around sovereign debt. He asks if it is appropriate to allow sovereign ratings on countries which are subject to an internationally agreed program. In any event, he said that rating agencies must follow a methodology which is both specific and very rigorous when they rate sovereign debt, and they must be held accountable by regulators.

SEC Official Details Efforts to Reform Rating Agencies to a Congressional Panel Concerned with International Coordination

Noting that credit ratings of mortgage-related and other structured finance instruments played a significant role in the financial crisis, SEC Deputy Director of Trading and Markets John Ramsay told a congressional panel that the Commission’s is addressing conflicts of interest, making more transparent the process for rating structured securities, and promoting competition among rating agencies. In testimony before the House Oversight and Investigations subcommittee, he said that the SEC has proposed regulations under the Dodd-Frank Act designed to strengthen the existing conflict of interest rule for rating agencies to more completely separate the credit analysis function from sales and marketing activities.

The regulations would prohibit an NRSRO from issuing or maintaining a credit rating when an employee who participates in sales or marketing activities also participates in determining a credit rating or in developing the procedures or methodologies used to produce the credit rating. They would also create a mechanism for a small NRSRO to seek relief from this absolute prohibition if, due to the size of the NRSRO, the separation of sales and marketing activities from the production of credit ratings is not appropriate. The proposals also set forth findings the Commission would need to make to suspend or revoke the registration of an NRSRO upon a finding that the NRSRO violated the conflict of interest rule. The SEC also proposed a new rule requiring a rating agency to have procedures addressing the potential for a credit rating to be influenced by a credit analyst seeking employment with the entity being rated or the issuer, underwriter, or sponsor of the securities being rated.

Another proposed regulation would require a rating agency to have policies designed to improve the integrity of its credit ratings procedures and methodologies. More specifically, the proposal would require procedures reasonably designed to ensure that the methodologies the NRSRO uses to determine credit ratings are approved by its board of directors and that such methodologies are developed and modified in accordance with the policies and procedures of the NRSRO and that any material changes to the methodologies are applied consistently, and that they are applied to currently outstanding credit ratings within a reasonable period of time. The rating agency would also have to promptly publish notice of material changes to rating methodologies and of any significant errors that are identified in a rating methodology.

Subcommittee Chairman Randy Neugebauer (R-TX) said that the debt ceiling negotiations and the long-term fiscal health of the U.S. have brought a renewed focus on the credit rating agencies. On the one hand, the Dodd-Frank Act attempts to de-emphasize the role of credit rating agencies in federal regulations and, on the other hand, the Act further entrenches the government-sponsored oligopoly of the big three credit rating agencies. The former approach to reduce reliance on credit rating agencies enjoys widespread bipartisan support, the Chair noted.

Section 939A of the Dodd-Frank Act directs the Commission, along with all other federal agencies, to remove references to credit ratings from its rules and forms and to substitute such alternative standards of creditworthiness as the Commission determines to be appropriate. Mr. Ramsay said that in each case the SEC’s goal is to reduce undue reliance on credit ratings and to encourage independent assessments of creditworthiness.

Chairman Neugebauer asked if the agencies have published standards of creditworthiness. The regulators, the SEC, OCC and Fed, described the effort as tricky and complicated. One challenge is around bank capital rules, and there is complexity because bank capital rules are inter-agency, and are also negotiated internationally and international accords contain credit references. Chairman Neugebauer likes the interagency approach, the approach needs to be standardized. He emphasized that the US cannot talk about Basel accord harmonization until it has its own coordinated plan.

Financial Services Committee Chair Spencer Bachus (R-ALA) acknowledged that 939A is giving regulators some problems. Section 939A replaces reliance on credit ratings with alternative methods, he noted, which could include ratings as part of the mix.

Chairman Bachus also noted that the European Union is making great efforts to end their reliance on rating agencies. He referred to recent remarks by EU Commissioner for the Internal Market Michel Barnier that the Commission has as a top priority addressing reliance on credit ratings. Commissioner Barnier said that credit ratings are too embedded in legislation and that he intends to reduce as much as possible the references made to those ratings in prudential rules.

Chairman Bachus urged the SEC, OCC and Fed to coordinate with the European Commission’s efforts. Chairman Bachus also conceded that it is a complicated job and that Congress intended to give discretion to expert regulators, but that Congress also intended to give direction. Section 112 of Dodd-Frank is such direction and pursuant to it he urged the regulators to use the Financial Stability Oversight Council as a coordinating body for efforts to remove reliance on ratings in agency regulations.

Virginia Proposes Private Adviser Exemption

The current definition exclusion for investment advisers and federal covered advisers whose only clients are corporations, general partnerships and other entities with assets of at least $5 million would be proposed for repeal and replaced with an exemption for certain private advisers, to take effect September 2, 2011. Interested persons may submit written comments about the proposal to Joel H. Peck, State Corporation Commission, c/o Document Control Center, P.O. Box 2118, Richmond, Virginia, no later than August 29, 2011. A hearing will not take place unless the Virginia Corporation Commission receives public comments about why it should be held and why the proposal cannot be adopted by written comments alone.

As proposed, Investment advisers and federal covered advisers, as well their employed investment adviser representatives, whose only clients are corporations, general partnerships and other entities with assets of at least $5 million would be exempt from registration in Virginia if the clients receive investment advice based on the clients' (entities') investment objectives rather than on their shareholders', partners', beneficiaries' or members' individual investment objectives. Also, the investment advisers must: (1) have been exempt from registration under Section 203(b)(3) of the Investment Advisers Act of 1940 as of July 20, 2011; and (2) be subject to SEC Rule 203-1(e) allowing an exemption from SEC registration until March 30, 2012 for investment advisers formerly exempt by Section 203(b)(3) of the 1940 Act that would otherwise need to register with the SEC by July 21, 2011.

Tuesday, July 26, 2011

Hong Kong SFC Enforcement Director Discusses Criminal vs Civil Actions in Market Misconduct Cases and Use of Sec. 213

The Hong Kong Securities and Futures Ordinance earmarks insider dealing and market manipulation as criminal offences, noted Mark Steward, Enforcement Director for the Securities and Futures Commission, and they should be prosecuted as crimes where there is sufficient evidence to establish the case to the criminal standard of proof and a prosecution is not otherwise inconsistent with public policy. In recent remarks, he said that there is some confusion between criminal prosecutions and civil proceedings before the Market Misconduct Tribunal.

Both procedures deal with the wrongdoer and both apply deterrent sanctions, albeit with different degrees of severity and using different standards of proof. The securities legislation provides that if a market misconduct case is brought before the Tribunal then the parties involved cannot be prosecuted criminally for the same misconduct. In effect, the commencement of Tribunal proceedings confers an automatic statutory immunity from prosecution for the same misconduct. The rationale for this immunity is the double jeopardy rule that a person cannot be punished for the same misconduct twice.

The Securities and Futures Ordinance recognizes that the Tribunal is involved in the application of deterrent or quasi-deterrent sanctions and a person should not also face punishment for the same conduct through the criminal process. Legislative history indicates that the purpose of the Tribunal is to inquire into and punish all forms of market misconduct, albeit using these powers calibrated to the civil rather than the criminal, standard of proof.

According to the Director, the Commission gives priority to criminal proceedings over Tribunal proceedings where the conduct in question can be established to the criminal standard of proof and it is in the public interest to prosecute the case. The SFC will not commute what is otherwise a criminal offence into a civil contravention. If the evidence does not support the laying of criminal charges, but is still sufficient to establish market misconduct using the lower civil standard of proof, then the SFC will refer the case to the Financial Secretary to consider initiating Tribunal proceedings.

The Director turned to a discussion of Section 213 of the SFO which permits the Commission to make applications to the Court of First Instance where a person has contravened the law. Under this provision, the court can order injunctions and, in effect, make orders reversing the consequences of alleged contraventions for the benefit of those who are on the adverse end of them. Section 213 actions are being used when defendants are not within the jurisdiction and thus criminal proceedings cannot be commenced. However, unlike a criminal prosecution or Tribunal proceedings, these cases are not concerned with punishment or deterrent sanctions against the wrongdoer. Instead, they are directed to the consequences of wrongdoing

The jurisdiction invoked here is a new one, acknowledged the Director. Section 213 has been in the legislation since it was enacted but it has not been used very often. Despite a recent judicial setback, the Commission is determined to give effect to the language and the purpose of the provision. While its use raises several novel questions, said the Director, in one sense the jurisdiction is an old one, akin to the well established equitable jurisdiction of the court to disaffirm or repudiate contracts induced by fraud.

In the case of insider dealing, insiders who possess inside information, by their conduct, represent to the market generally and to corresponding buyers and sellers, in particular, that they are legally competent to trade when in fact they are prohibited from doing so. In effect they misrepresent their status, position as well as their competence i.e. ability to trade. All of these matters would give rise to remedies for misrepresentation in a face to face transaction. The falsity of the insider’s representation is not detectable because all traders are anonymous, said the Director, yet the representation is as false as any false statement in a fraud case. In the case of market manipulation, the falsity of the representations arises from the false appearance of real market activity.

The rationale for pursuing cases seeking both deterrent and remedial sanctions is the Commission’s view that as the champion of market integrity and fairness, as well as the agency with a statutory mandate to protect investors, the SFC has a duty not only to bring cases against wrongdoers but also to attack and remediate the consequences of wrongdoing.

Recently, the Court of First Instance ruled that only a court exercising criminal jurisdiction or the Market Misconduct Tribunal has jurisdiction to determine whether a contravention of Hong Kong’s insider dealing and market manipulation laws has occurred, with the result that the Securities and Futures Commission cannot seek final orders under section 213 without such a prior determination.

The Securities and Futures Ordinance created a dual regime of civil actions before the Market Misconduct Tribunal or criminal proceedings, noted the court, and does not contemplate a tripartite regime with, in addition to criminal prosecution or an inquiry by the Market Misconduct Tribunal, a third procedure by which the Commission could ask the court to determine whether there had been a violation of the insider dealing provisions. The SFC challenges the correctness of this court decision and intends to appeal the ruling.

Kansas Provides Temporary Exemption for IAs Following Dodd-Frank 7/21/2011 Effective Date

Investment advisers exempt from SEC registration as of July 20, 2011 by virtue of the de minimis exemption at Section 203(b)(3) of the Investment Advisers Act of 1940 are exempt from registration in Kansas from July 21, 2011 through March 30, 2012, provided the investment advisers: (1) had fewer than 15 clients during the preceding 12 months; and (2) neither held themselves out generally to the public as investment advisers nor acted as investment advisers to any investment company registered under the Investment Company Act of 1940 ("IC Act") or a company electing (and not withdrawing its election) to be a business development company under Section 54 of the IC Act. Similarly, investment adviser representatives employed by investment advisers covered by the temporary exemption are, themselves, exempt from registration in Kansas until March 30, 2012. NOTE: This administrative order of the Kansas Office of the Securities Commissioner supersedes an intepretive order on hedge funds from November 4, 2008.

UK Regulator Endorses Comply-or-Explain Principle in Comments on Corporate Governance Green Paper

The UK accounting and auditing regulator strongly endorsed the continuing efficacy of comply-or-explain corporate governance codes in comments on the European Commission’s Green Paper on corporate governance. The comply-or-explain principle is recognized at the European level as an important tool for delivering good corporate governance, noted the Financial Reporting Council, but the Green Paper raises questions about its effectiveness. Comply-or-explain offers flexibility that is positive for economic activity, said the FRC, and should not be replaced or watered down with arrangements which might stifle entrepreneurialism. While asserting that comply-or-explain should be retained as an important principle in EU corporate governance, the FRC agreed with the Green Paper that it should be made to work more effectively, adding that there is a need for more reliable monitoring and a better quality of explanations.

For example, the FRC said that regulators should pick up on instances where there is no explanation for a breach of the Code. The Financial Reporting Review Panel, which reviews narrative and financial reporting, already monitors on behalf of the Financial Services Authority the mandatory corporate governance disclosures required under the 4th and 8th Company Law Directives, and the FRC is considering whether this role might be extended.

The Green Paper suggests that the quality of explanations might be improved by making company corporate governance statements regulated information under the Transparency Directive. This would give regulators the power to intervene directly where explanations were deemed inadequate. But the FRC fears that this approach could lead to situations where regulators would usurp the right of shareholders to assess the acceptability of explanations, which is an essential pillar of the comply-or-explain concept.

Such an approach cannot even be contemplated until there is a clear consensus in each market about what constitutes an explanation. The UK Code states that in providing an explanation companies should illustrate how their actual practices are consistent with the relevant principle of the Code, which is divided into high-level principles and more detailed provisions, with only the provisions being subject to comply-or-explain.

If there should be regulatory oversight, said the FRC, it must not intrude on shareholder judgments. What must be avoided is a compliance-driven box-ticking approach in which companies would be tempted to check in advance with regulators whether an explanation was appropriate, thereby placing shareholders outside the loop.

The FRC suggested that a limited acceptable scenario for regulatory oversight might be for shareholders to refer to the regulator explanations which in the shareholder’s view clearly failed to meet the agreed criteria, if engagement with the company had failed to elicit a more informative explanation. The regulator would then be able to insist on a better quality explanation. This should provide a particular boost to the quality of explanations, especially in countries where they are weak.

The FRC corrected two misconceptions about the comply-or-explain doctrine. First, the frequent assertion that comply-or-explain is self-regulation is incorrect. Indeed, a comply-or-explain approach depends on regulation to make it effective. There must be a formal requirement for transparency, so that companies covered by the regime are obliged to state publicly whether they comply with relevant provisions, explain publicly when they do not and demonstrate how the resulting governance arrangements meet the relevant principle. Thus, the comply-or-explain approach uses regulation to enhance accountability. It does not allow companies to regulate themselves.

Second, the political debate sometimes seems to revolve around the flawed notion that there is a choice between two systems: formal regulation or comply-or-explain. Even in the UK, where the comply-or-explain principle is probably most developed, market participants recognize the need for regulation. The key challenge is deciding on the right mix of formal regulation and comply-or explain provisions.

According to the FRC, comply-or-explain corporate governance codes have many advantages. They can be modified regularly to take account of changing market circumstances and to encourage incremental increases in standards, thus promoting continuous improvement. In the UK, the FRC normally reviews the Corporate Governance Code every two years. In other member states such as Germany, there is an annual review. It is not possible to amend legislation this frequently, said the FRC, and Codes are therefore more adaptable.

Also, Codes frequently focus on behavioral expectations which are difficult to capture in regulation or where regulation would be premature. For example, the practice of board evaluation has been growing in the UK since it was first recommended in the UK Corporate Governance Code in 2003. This is now being extended to encourage regular evaluation by an independent external reviewer, which in turn is encouraging the development of a more professional market in board reviews. The Code has thus brought about a change in culture with regard to board reviews and enabled expectations with regard to standards to be progressively raised. A regulatory approach would have been more difficult, reasoned the FRC, since it would have involved a one-off requirement to conduct board evaluation that would be difficult to impose when the market in board reviews was not yet developed.

It may even be possible to achieve more robust outcomes with a comply-or-explain Code than would be available through negotiation of Directives and regulation. An example is the arrangement for audit committees. Before the introduction of the 8th Company Law Directive in 2006, noted the FRC, the UK had already achieved virtually universal compliance with Code requirements for listed companies to have fully independent audit committees. Audit committees became a statutory requirement with the introduction of the Directive, but, because member states could not agree on the level of independence required, the Directive only requires one member of the committee to be independent. The UK Code outcome was thus more robust.

UK FSA Official Views Proposed Regulations under EU Hedge Fund Directive

A senior UK Financial Services Authority official has examined the proposed regulations issued under the EU hedge fund Directive by the European Securities and Market Authority (ESMA). The proposals were issued at the request of the European Commission. In remarks at a PwC global alternative investments seminar, Sheila Nicoll, Director of Conduct Policy, discussed leverage, risk management, depositary liability and transparency around the Alternative Investment Fund Managers Directive, 2011/61/EU.

She noted that, in many cases, the proposed regulations have been aligned to existing requirements in the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive or Markets in Financial Instruments Directive (MIFID). But in others, the AIFMD is in new territory, requiring new rules on leverage for example. The proposed regulations are in two stages. The first stage is a set of proposals on non-passport areas, which has just been issued, while the second set to be proposed later in the summer will deal with passport issues.
Depositaries are a highly sensitive subject which has received a lot of political scrutiny. Several important principles in this area were agreed to during the original debate on the Directive, but authority was delegated to the Commission to develop more detailed rules covering some very significant policy issues. According to the Director, one of the most contentious aspects of this part of ESMA's proposed rules is the liability of a depositary to provide restitution to the fund for lost assets.

ESMA is consulting on whether the starting point should be an assumption that the depositary should be liable for the actions of its sub-custodians as if those actions were performed by the depositary itself. The UK official noted that, when delegating custody to its sub-custodians, the depositary must follow the comprehensive due diligences procedures which are in the ESMA advice, and monitor them on an ongoing basis. Ms. Nicoll finds it counterintuitive that the robust requirements proposed by ESMA do not change the extent to which the depositary is liable for actions within its sub-custodians. She questions if this mean that the depositary will be liable for events outside its reasonable control.

ESMA considers that depositaries must identify and monitor potential loss events if they want to avoid liability for the loss. The proposal also says that depositaries, in some cases, must take additional appropriate actions but unfortunately it does not then go on to explain what these are. The Director urged ESMA to explain what these additional actions look like and when they must be taken.
ESMA has also considered the relationship between the depositary and prime broker which is particularly important in the hedge fund area. Depending on the option selected in relation to the financial instruments that can be held in custody, noted the FSA official, the prime broker could be viewed as a sub-custodian to the depositary when holding assets as collateral. This may not be an optimal outcome, said the official, and it is important that the consultation fully examine the consequences if this were the final result.

Under the Directive, the fund manager must for each fund it manages, that is not an unleveraged closed-ended fund, employ an appropriate liquidity management system and adopt procedures which enable it to monitor the liquidity risk of the fund and ensure that the liquidity profile of the investments of the fund complies with its underlying obligations. The fund manager must regularly conduct stress tests, under normal and exceptional liquidity conditions, which enable it to assess the liquidity risk of the fund and monitor the liquidity risk accordingly.

Regarding leverage, the Director said the focus here needs to be on proportional application and robust methodology. With regard to proportional application, ESMA seeks to take account of how the fund and its investors view leverage by providing for an advanced method allowing for tailoring by the manager so as both to meet the disclosure needs of investors and to act as a reasonable benchmark against which maximum leverage limits can be assessed. A robust methodology should help limit the extent to which leverage can be hidden behind layers of derivatives or via complicated hedging and netting relationships.

The Directive requires fund managers to implement and annually review adequate risk management systems in order to identify, manage and monitor appropriately all risks relevant to each fund investment strategy and to which each fund is or can be exposed. Overall, noted Ms. Nicoll, risk management has been a relatively uncontentious area since it draws heavily on existing UCITS requirements. The one area of contention is around the provision of a non-exhaustive list of specific safeguards the fund manager should apply against conflicts of interest to ensure the independent performance of risk management activities. The debate relates to whether all or certain safeguards should be mandatory. The Director would like to see comments on what the impact of these safeguards would be in practice, particularly for smaller firms, and their likely effect on cost or potential to create barriers to entry.

The Directive requires an independent performance of the valuation function, but this can be done within the fund manager or by an external valuer. ESMA clarifies that the valuation function refers only to the valuation of individual assets and not the administrative function of calculating the NAV; and that there can be more than one external valuer. In the view of the FSA official, the implications are that fund administrators that calculate the NAV should not be considered to be external valuers. She also noted that, when a fund manager performs the valuation function it can still delegate or separately contract with third parties for the performance of some of the tasks involved, provided it retains responsibility for the valuation function itself.

One of the main objectives of the Directive is to increase the transparency of AIFM vis-à-vis investors and regulators. In furtherance of this goal, the Directive includes requirements regarding the annual report of the fund, initial and ongoing disclosure to investors and reporting to competent authorities. ESMA has proposed that all fund managers should be required to report to the competent authorities on a quarterly basis. The Commission’s mandate asked ESMA to provide advice on the appropriate frequency of such reporting, taking account the potential risks posed by specific types of fund managers. The FSA Director encouraged commenters to consider the extent to which they feel that that Commission’s mandate has been met, and the practicalities and costs of such reporting in practice.

Monday, July 25, 2011

Kansas Monitoring SEC Developments Following Dodd-Frank

The Office of the Securities Commissioner of Kansas, Aaron Jack, is monitoring federal developments following adoption of the SEC rules for private advisers, effective July 21, 2011, in accordance with the timetable set forth by the Dodd Frank Wall Street Reform and Consumer Protection Act. The Commissioner gives advisers to private funds until March 30, 2012 to register in Kansas if necessary and before that date will consider adopting a proposed model rule exemption for private fund advisers.

Sunday, July 24, 2011

District of Columbia Sets Forth Procedures for D.C. Advisers Following Dodd-Frank

Investment advisers transacting business in the District of Columbia on or after July 21, 2011, the date the private fund adviser provisions of the Dodd-Frank Act took effect, must abide by the following procedures:

* Advisers with less than $100 million in assets under management must license with the D.C. Department of Insurance, Securities and Banking ("Department") before June 28, 2012 to conduct business in the District of Columbia after that date. These advisers if registered with the SEC before July 21, 2011 will remain registered with the SEC until January 1, 2012 when they will have until March 30, 2012 to file Form ADV stating their switch to state registration. Investment advisers ineligible for SEC registration must file Form ADV-W, Application for Withdrawal from Investment Adviser Registration, with the SEC between March 30, 2012 and June 28, 2012, the date the advisers must be licensed in the District of Columbia. To be licensed in the District of Columbia by June 28, 2012 these advisers must follow the implementation schedule of SEC Rule 203A-5 and also, between January 1, 2012 and March 30, 2012, submit a licensing application to the Department to be processed but remain pending until the SEC accepts the firm's Form ADV-W at which time the application becomes effective in the District of Columbia upon the Department's approval.

The above advisers if not registered with the SEC before July 21, 2011 may not offer advisory services in the District of Columbia after July 21 unless they are licensed by the Department or not subject to licensing requirements because of Section 31-5602.02 of the District of Columbia Securities Act.

* Exempt reporting advisers under SEC Rules 203(l)-1 or 203(m)-1 that act as advisers in the District of Columbia without a D.C. exemption from licensing must submit an application to the Department between January 1, 2012 and February 28, 2012 to ensure licensing by March 30, 2012, the date of required licensure for continued transaction of advisory business in the District.

* Advisers to pension funds with less than $200 million in assets under management (former SEC Rule 203A-2(b)) that act as advisers in the District of Columbia without a D.C. exemption from licensing must submit an application to the Department on or before the expiration of 180 days of advisers' fiscal year-end, the date of required licensure for continued transaction of advisory business in the District.

Missouri Advises IAs to 3(c)(1) and (7) Funds Through No-Action Letter

A no-enforcement action letter request was granted by the Missouri Securities Division for a Missouri investment adviser to 3(c)(1) funds under the Investment Company Act of 1940. The investment adviser's exemption from registration in Missouri applies until either June 28, 2012 or the date the Missouri Securities Division adopts a new private fund adviser rule, whichever date comes first. The Dodd-Frank Act's rendering the Section 203(b)(3) federal private fund adviser exemption ineffective on July 21, 2011 simultaneously made Missouri's existing Section 203(b)(3) private fund adviser exemption at Rule 3-51.180(6) ineffective. Advisers to 3(c)(1) and 3(c)(7) funds, without the temporary no-action letter, would have to register in Missouri or find another available exemption.

Floor Amendments to Legislation Restructuring CFPB Would Improve Transparency, Prevent Conflicts of Interest and Address Language Barriers

A series of bi-partisan Floor amendments to House legislation (HR 1315) restructuring the Consumer Financial Protection Bureau would improve transparency, prevent conflicts of interest and nationally elevate language barrier concerns. The legislation would designate one of the five Commissioners to oversee the Bureau's activities pertaining to protecting consumers who are older, minorities, youth, or veterans, from unfair, deceptive, and abusive lending practices. The designated Commissioner must ensure that the Bureau conducts regular outreach to consumers regarding industry lending activities and must report to the full Commission, on a regular basis the impact of new loan and credit products and services on consumers. The designated Commissioner must also ensure that the Bureau coordinates with State-level consumer protection agencies on enforcement measures that protect consumers from unfair, deceptive, and abusive lending practices.

Pursuant to a floor amendment offered by Rep. Judy Chu (D-CA), the designated Commissioner must report to the full Commission about ways to protect consumers from unfair, deceptive, or abusive lending acts or practices, including how language barriers contribute to lack of understanding in lending activities. The Chu Amendment would require research on how language barriers can lead to unfair and abusive lending practices, and a report to the full Commission on ways to protect consumers from potentially unfair and deceptive practices. According to Rep. Chu, the designated Commissioner would be someone on a national level looking out for people who are being duped because of language barriers. Cong. Record, July 21, 2011p. H5338.

Relevant to the Chu Amendment, Rep. Shelley Moore Capito (R-WV), and floor manager of HR 1315, noted that the CFPB is already planning for multilingual outreach and understanding. During a conference call with a large number of bipartisan congressional staff, the senior officials at the CFPB indicated that the Bureau would have the capacity to translate into 180 languages. That is a very broad reach, said Rep. Capito, who added that there are other foreign language disclosures outreach by the Secretary of the Treasury to help persons facing language barriers and other aspects around the same issue that the Chu Amendment addresses.

Pursuant to a floor amendment offered by Rep. Peter DeFazio (D-OR), no member of the Council may vote on the decision to issue a stay of, or set aside, any Bureau regulation if the member has, within the previous two-year period, been employed by any company or other entity that is subject to that regulation. According to Rep. DeFazio, this amendment addresses revolving door issues to prevent potential conflicts of interest. The Council Member would have to sit out the vote but can still serve on the Council. Thus, if a proposed Bureau regulation directly affects their previous employer and they have been on the Council less than 2 years, they would have to sit out that particular vote. They can serve and vote on any and every other procedure, but just not on that particular thing. It's a very restrictive conflict of interest rule, said Rep. DeFazio. Cong. Record, July 21, H5334.

Under an amendment offered by Rep. Erik Paulsen (R-MN), the five non-voting Members of the Financial Stability Oversight Council, including a State insurance regulator and a State banking regulator would have the authority to challenge any regulations that are put forth by the Consumer Financial Protection Bureau. For example, while it is clear that the CFPB does not have the authority to regulate insurance, it could put forth a regulation that actually negatively impacts the industry and the economy, noted Rep. Paulsen, so it makes sense that all the Members on the Council have the ability to consider the impact that these new rules may have. The intent of the Paulsen Amendment is to improve the oversight on the CFPB by clarifying that any Member of the Financial Stability Oversight Council, including non-voting Members, may question any regulation and bring that up for clarification. Cong. Record, July 21, 2011, H5334

The legislation requires that when the Financial Stability Oversight Council meets to deliberate on a CFPB regulation, those meetings would be open to the public. The Quigley Amendment takes that one step further and would require that the meeting be live-streamed over the Internet. According to Rep. Mike Quigley (D-IL), the transparency goal of the legislation requires that the entire American public have access to these meetings over the Internet, not just people in one city. This is important to both supporters and critics of the CFPB, he noted. If a CFPB ruling is challenged by the FSOC, the subsequent proceedings should be more open, transparent, and accessible. Transparency will help ensure that all parties, banks and consumers, get a fair hearing.

Pursuant to an amendment offered by Rep. James Lankford (R-OK), a mechanism for Bureau transparency would require the Inspectors General of the Board of Governors of the Federal Reserve and the Consumer Financial Protection Bureau to post online and submit an annual report to Congress each February 1 illuminating four key elements in the bureau's operations during the previous fiscal year: 1) a list of all new guidelines and regulations prescribed by the Bureau within the previous fiscal year with corresponding descriptions of each; 2) a detailed list of all authority that the Federal Reserve Inspector General deems in conflict with other Federal departments and agencies, which is designed to highlight redundant functions within other federal agencies in order to improve efficiency within the entire U.S. financial regulatory structure.; 3) administrative expenses of the Bureau, including the amount spent on salaries, office supplies, and office space; and 4) the current balance at the Consumer Financial Protection Bureau, their fund itself.

An amendment offered by Rep. Scott Rigell (R-VA) would require the Consumer Financial Protection Bureau to submit a financial impact analysis to the FSOC, and also make the analysis publicly available, on each proposed rule or regulation that it intends to adopt. It would expand the cost analysis to include financial institutions of all sizes, not just the smaller ones that are currently under the cost analysis portion. Most importantly, the Rigell Amendment would require the Bureau to submit an analysis to the Council on how the proposed regulation would impair the ability of individuals and small businesses to access credit. According to Rep. Rigell, the amendment offers a reasonable solution that just would require the Bureau to pause and to calculate and to distribute to the public a clear indication of the impact that the regulation would have both on the lending institution and on credit for small business owners and individuals. Cong. Record, July 21, 2011, H5338.

Saturday, July 23, 2011

UK Regulators Emphasize Continued Relevance of True and Fair Principle under GAAP and IFRS

UK regulators have issued a report emphasizing and reaffirming that the requirement that audited financial statements give a true and fair account of a company’s operations remains of fundamental importance under both UK GAAP and IFRS. The Accounting Standards Board and the Auditing Practices Board also confirmed that fair presentation under IFRS is equivalent to a true and fair view. The Boards expect preparers and auditors of financial statements to always stand back and ensure that the financial accounts as a whole give a true and fair view and to be prepared, albeit in extremely rare circumstances, to consider using the true and fair override. They must also ensure that the consideration they give to these matters is evident in their deliberations and documentation. In the US, the analogous principle is that financial statements must fairly present the company’s financial picture.

The introduction of IFRS in the UK did not change the fundamental requirement for financial accounts to give a true and fair view. The true and fair concept has been a part of English law and central to accounting and auditing practice in the UK for many decades. There has been no statutory definition of true and fair. The most authoritative statements as to the meaning of true and fair have been legal opinions written by Lord Hoffmann and Dame Mary Arden in 1983 and 1984 and by Dame Mary Arden in 1993. Since those Opinions were written, there have been some significant changes in accounting standards and company law which have led some to question whether the views expressed in those Opinions remain applicable.

In these circumstances, the Boards concluded that it would be helpful to its preparers, auditors and users of financial statements if it commissioned a further legal opinion to ascertain whether the approach to true and fair taken in the Hoffmann-Arden Opinions needs to be revised. They instructed Martin Moore QC and his Opinion is now published on the FRC website.

In his Opinion, Mr. Moore endorsed the analysis in the Opinions of Lord Hoffmann and Dame Arden and confirmed the centrality of the true and fair requirement to the preparation of financial statements in the UK, whether they are prepared in accordance with international or UK accounting standards. The true and fair concept remains paramount in the presentation of UK company financial statements, even though the routes by which that requirement is embedded may differ slightly.

In his Opinion, Mr. Moore notes that, in relation to the gradual shift over time to more detailed accounting standards, that it does not follow that the preparation of financial statements can now be reduced to a mechanistic process of following the relevant standards without the application of objective professional judgment applied to ensure that those statements give a true and fair view, or achieve a fair presentation.

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

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

The earlier Lord Hoffmann-Dame Arden Opinions noted that true and fair is a legal concept and the question of whether a company’s financial statements comply with it can be authoritatively decided only by a court. The law uses these types of concepts, another example of which is reasonable care, and they are seldom difficult to understand, noted the Opinion, but generate controversy in their application to specific factual situations. There will always be a penumbral area where views may reasonably differ, said Lord Hoffman and Dame Arden.

In his opinion in Her Majesty's Revenue & Customs v William Grant & Sons Distillers Limited, Lord Hoffmann said that, although the requirement that the initial computation must give a true and fair view involves the application of a legal standard, the courts are guided as to its content by the expert opinions of accountants as to what the best current accounting practice requires. The experts will in turn be guided by authoritative statements of accounting practice issued or adopted by the Accounting Standards Board.

A 2001 opinion on true and fair obtained by the Hong Kong Society of Accountants noted that the concept is a dynamic one whose meaning remains the same over time, but whose contents could be expected to change.

Joint SEC, CFTC, Fed Report Outlines Fed’s Role under Dodd-Frank in Oversight of Systemically Important Clearing Entities

The SEC, CFTC and the Fed have submitted a report to Congress mandated by the Dodd-Frank Act on the risk management of clearing entities and derivative clearing organizations that are deemed to be systemically important by the Financial Stability Oversight Council. Section 813 of Dodd-Frank requires that the SEC and CFTC coordinate with the Fed to jointly develop risk management supervision programs for clearing entities that have been designated as systemically important by the Council.

For these purposes, a clearing entity is either a derivatives clearing organization registered with the CFTC or a clearing agency registered with the SEC under Section 17A of the Securities Exchange Act. Broadly, the report and accompanying recommendations enhance the role of the Fed in the regulation and examination of systemically important clearing entities. Ultimately, the agencies envision a mechanism for implementing information sharing through a Memorandum of Understanding among the CFTC, the SEC, and the Fed.

In Title VIII of Dodd-Frank, Congress found that the proper functioning of the financial markets is dependent upon safe and efficient arrangements for the clearing and settlement of securities and derivatives transactions. The entities providing these arrangements are known as financial market utilities. Title VIII applies to financial market utilities designated by the Council as systemically important based on a determination that the failure or disruption to the functioning of the utility could create the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system. Designated clearing entities are a subset of designated financial market utilities.

Generally, the supervisory programs of the SEC, CFTC and the Fed are conducted in an autonomous manner. However, with Title VIII, Congress has provided a new cooperative supervisory framework for designated clearing entities that provides requirements for enhanced risk management, a greater focus on systemic risk both within and across designated clearing entities, an enhanced role for the Board in the supervision of risk management standards for these systemically important financial market utilities and closer consultation among the CFTC, the SEC, and the Board.

It is important to note that the new Title VIII supervisory framework does not replace the existing supervisory programs at the SEC and CFTC. Rather, the new framework builds on each agency’s existing program with an interagency consultative process designed to enhance and reinforce existing supervisory programs through the benefits of shared expertise and information among the CFTC, the SEC, and the Board. The joint report makes five specific recommendations designed to achieve this goal.


First, the CFTC and the SEC should finalize regulations establishing enhanced risk management standards for derivatives clearing organizations and clearing agencies, including designated clearing entities, but in consultation with the Fed. The CFTC and the SEC should continue Fed consultation in connection with future agency rulemakings related to changes in risk management standards for designated clearing entities. Second, the CFTC and the SEC should formalize a process for consulting with the Fed regarding proposed material changes to the rules, procedures, or operations of designated clearing entities.

Third, the CFTC, the SEC, and the Board should implement an ongoing consultative mechanism promoting a shared understanding of potential systemic risks, and an exchange of insights on effective risk management practices and techniques. The ongoing consultative mechanism should consist of an annual planning and coordination meeting, said the report, supplemented by ongoing dialogue and periodic meetings as needed. The purpose of the meeting and ongoing dialogue should be to identify emerging risks, discuss key risk issues that may be examined by each agency, and help inform effective supervisory responses to such risks.

Fourth, the CFTC and the SEC should develop a process for annual consultation with the Fed at least once a year regarding the scope and methodology of their planned examinations of designated clearing agencies for which each is the regulator and providing the Board the opportunity to participate on such examinations. Obviously, the CFTC and the SEC must lead the examinations within their respective jurisdictions as provided for by Section 807(d) of Dodd-Frank. But consultations with the Fed on the scope and methodology of the examinations and participation by the Board on relevant examinations are important elements to enable the Board to carry out its responsibilities under Title VIII. In fact, the Fed expects to participate on each relevant examination of a designated clearing entity where practicable as allowed under Section 807(d)(2) of Dodd-Frank.

Fifth, the CFTC, the SEC, and the Fed should develop a process for appropriate information sharing related to designated clearing entities. Title VIII authorizes such information sharing in Section 809 pursuant to which the agencies plan to develop an appropriate process for regular information exchange. The process should cover procedures for sharing, and preserving the confidentiality of, written and oral information such as examination reports, information about material concerns, and other appropriate confidential supervisory information. The agencies believe that one possible mechanism
for implementing such information sharing may be through a Memorandum of Understanding (MOU) among the CFTC, the SEC, and the Board.

Friday, July 22, 2011

Appeals Court Panel Vacates SEC Proxy Access Rule as Arbitrary and Capricious

A unanimous panel of the DC Circuit Court of Appeals ruled that the SEC was arbitrary and capricious in promulgating the process access rule, Exchange Act Rule 14a-11, and vacated the rule. Among other things, the appeals panel found that the SEC’s discussion of the estimated frequency of nominations under Rule 14a-11 was internally inconsistent and therefore arbitrary. The Commission anticipated frequent use of Rule 14a-11 when estimating benefits, but assumed infrequent use when estimating costs. The appeals court also found that the Commission relied upon insufficient empirical data when it concluded that Rule 14a-11 will improve board performance and increase shareholder value by facilitating the election of dissident shareholder nominees. Business Roundtable and Chamber of Commerce v. SEC, DC Circuit, No. 10-1305, July 22, 2011.

Writing separately on the application of the proxy access rule to investment companies, the appeals panel found that the SEC failed to adequately address whether the regulatory requirements of the Investment Company Act would reduce the need for, and hence the benefit to be had from, proxy access for shareholders of investment companies, and whether the rule would impose greater costs upon investment companies by disrupting the unique structure of their governance.

The proxy process is the principal means by which shareholders of a public company elect the board of directors. Typically, incumbent directors nominate a candidate for each vacancy prior to the election, which is held at the company’s annual meeting. Before the meeting the company puts information about each nominee in the set of proxy materials, usually comprising a proxy voting card and a proxy statement, it distributes to all shareholders. The proxy statement concerns voting procedures and background information about the board’s nominees and the proxy card enables shareholders to vote for or against the nominees without attending the meeting.

A shareholder who wishes to nominate a different candidate may separately file his or her own proxy statement and solicit votes from shareholders, thereby initiating a proxy contest. Rule 14a-11 provides shareholders an alternative path for nominating and electing directors. Concerned that the current process impedes the expression of shareholders’ right under state corporation laws to nominate and elect directors, the Commission adopted the rule with the goal of ensuring the proxy process functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders. Rule 14a-11 requires a company subject to the Exchange Act proxy rules, including an investment company registered under the Investment Company Act,, to include in its proxy materials the name of a person or persons nominated by a qualifying shareholder or group of shareholders for election to the board of directors.

To use Rule 14a-11, a shareholder must have continuously held at least 3% of the voting power of the company’s securities entitled to be voted for at least three years prior to the date the nominating shareholder submits notice of its intent to use the rule, and must continue to own those securities through the date of the annual meeting. The nominating shareholders must submit the notice, which may include a statement of up to 500 words in support of each of its nominees, to the Commission and to the company. A company that receives notice from an eligible shareholder or group must include the proffered information about the shareholders and their nominees in its proxy statement and include the nominee on the proxy voting card.

The Commission did place certain limitations upon the application of Rule 14a-11. The rule does not apply if applicable state law or a company’s governing documents prohibit shareholders from nominating a candidate for election as a director. Nor may a shareholder use Rule 14a-11 if he or she is holding the company’s securities with the intent of effecting a change of control of the company

The panel noted that the Commission has a unique obligation to consider the effect of a new rule upon efficiency, competition, and capital formation, and its failure to apprise itself, and hence the public and Congress, of the economic consequences of a proposed regulation makes promulgation of the rule arbitrary and capricious and not in accordance with law.

The appeals court held that the Commission acted arbitrarily and capriciously for having failed to adequately assess the economic effects of the new rule. The Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.

The panel reasoned that the Commission’s prediction that company directors might choose not to oppose shareholder nominees because their fiduciary duties would prevent them from using corporate funds to resist shareholder director nominations for no good-faith corporate purpose had no basis beyond mere speculation. While conceding the possibility that a board may, consistent with its fiduciary duties, forgo expending resources to oppose a shareholder nominee, the panel said that the SEC presented no evidence that such forbearance is ever seen in practice.

To the contrary, noted the panel, the American Bar Association Committee on Federal Regulation of Securities commented that if the shareholder nominee is determined by the board not to be as appropriate a candidate as those to be nominated by the board’s independent nominating committee, then the board will be compelled by its fiduciary duty to make an appropriate effort to oppose the nominee, as boards now do in traditional proxy contests.

In addition, the Commission’s point that the required minimum amount and duration of share ownership will limit the number of directors nominated under the new rule as a reason to expect election contests to be infrequent says nothing about the amount a company will spend on solicitation and campaign costs when there is a contested election. Although the Commission acknowledged that companies may expend resources to oppose shareholder nominees, observed the panel, it did nothing to estimate and quantify the costs it expected companies to incur; nor did it claim estimating those costs was not possible, for empirical evidence about expenditures in traditional proxy contests was readily available.

The panel also concluded that the Commission acted arbitrarily by ducking serious evaluation of the costs that could be imposed upon companies from use of the proxy access rule by shareholders representing special interests, particularly union and government pension funds. Despite Rule 14a-11’s ownership and holding requirements, the panel said that there is good reason to believe that institutional investors with special interests will be able to use the rule and that pension funds are the institutional investors most likely to make use of proxy access.

Nonetheless, the Commission failed to respond to comments arguing that investors with a special interest, such as unions and state and local governments whose interests in jobs may well be greater than their interest in share value, can be expected to pursue self-interested objectives rather than the goal of maximizing shareholder value, and will likely cause companies to incur costs even when their nominee is unlikely to be elected.

While the Commission was not unreasonable in predicting investors will use Rule 14a-11 less frequently than traditional proxy contests have been used in the past, noted the panel, in weighing the rule’s costs and benefits the Commission arbitrarily ignored the effect of the final rule upon the total number of election contests. That is, the Adopting Release did not address whether and to what extent Rule 14a-11 will take the place of traditional proxy contests. Without this crucial datum, reasoned the court, the Commission has no way of knowing whether the rule will facilitate enough election contests to be of net benefit.

Investment Companies

The panel separately discussed the application of the proxy access rule to investment companies. Lest the Commission on remand apply to investment companies a newly justified version of the rule only to be met in court again by valid objections, the panel thought it prudent to take up the more serious of the concerns posed by investment companies but left unaddressed by the Commission.

Investment companies, such as mutual funds, pool investors’ assets to purchase securities and other financial instruments. They are subject to different requirements, providing protections for shareholders not applicable to publicly traded stock companies. One investment adviser typically manages a family of mutual funds, and fund boards in a complex are generally organized in one of two ways: either there is a unitary board, comprising one group of directors who sit as the board of every fund in the complex, or there are cluster boards, comprising two or more groups of directors, with each group overseeing a different set of funds within the complex.

The court found that the Commission failed adequately to address whether the regulatory requirements of the Investment Company Act reduce the need for, and hence the benefit to be had from, proxy access for shareholders of investment companies, and whether the rule would impose greater costs upon investment companies by disrupting the structure of their governance. While the SEC recognized the significant degree of regulatory protection provided by the ICA, said the panel, it did almost nothing to explain why the rule would nonetheless yield the same benefits for shareholders of investment companies as it would for shareholders of operating companies.

The Commission also failed to deal with the concern that Rule 14a-11 will impose greater costs upon investment companies by disrupting the unitary and cluster board structures with the introduction of shareholder-nominated directors who sit on the board of a single fund, thereby requiring multiple, separate board meetings and making governance less efficient.

The Commission did acknowledge that it believed costs would be lower for investment companies because their shareholders are mostly retail investors; would be less likely to meet the three-year holding requirement; and would have fewer opportunities to use the rule because some investment companies may under state law elect not to hold annual meetings. It also determined disruptions to unitary and cluster boards could be mitigated through the use of confidentiality agreements in order to preserve the status of confidential information regarding the fund complex.

But the court found that these observations did not adequately address the probability the rule will be of no net benefit as applied to investment companies. First, the Commission failed to consider that less frequent use of the rule by shareholders of investment companies also reduces the expected benefits of the rule. Second, the Commission’s assertion that confidentiality agreements could meaningfully reduce costs was without any evidentiary support and was unresponsive to the contrary claim of investment companies that confidentiality agreements would be no solution because the shareholder-nominated director would have no fiduciary duty to other funds in the complex and, in any event, could not be legally obliged to enter into a confidentiality agreement.

Louisiana Adopts Supervisory Requirement for Dealers, IAs and FCAs

Dealers, investment advisers, federal covered investment advisers, and their officers, directors and partners in Louisiana, by new rule adopted effective July 20, 2011, must create, maintain and enforce written procedures for supervising their salespersons and investment adviser representatives.

Thursday, July 21, 2011

House Passes Legislation Restructuring Bureau of Consumer Financial Protection

On the one-year anniversary of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the House of Representatives passed legislation restructuring the Consumer Financial Protection Bureau created by the Act. The Consumer Financial Protection Safety and Soundness Improvement Act, HR 1315, would establish a bi-partisan, five-member Commission consisting of a Chair and four additional members to carry out all of the duties that would otherwise fall to the Director of the CFPB. Commission members would be appointed by the President, confirmed by the Senate, and would serve five-year terms.

The legislation would also amend Section 1023 of the Dodd-Frank Act, which addresses the Financial Stability Oversight Council’s review and oversight of Consumer Financial Protection Bureau regulations that may undermine the safety and soundness of U.S. financial institutions. The legislation would make four changes to the FSOC’s review procedures: (1) it would lower the threshold required to set aside CFPB’s proposed regulations from a two-thirds vote of the FSOC’s voting membership to a simple majority, excluding the Director of the CFPB; (2) it would clarify that the FSOC must set aside any CFPB regulation that is inconsistent with the safe and sound operations of U.S. financial institutions; (3) it would eliminate the 45-day time limit for the FSOC to review and vote on CFPB regulations; and (4) it would require that all FSOC meetings be open to the public whenever it decides to stay or set aside a CFPB regulation.

HR 1315 would also amend Section 1062 of the Dodd-Frank Act to delay any further transfer of powers to the CFPB until the later of the following: (1) July 21, 2011; or (2) the date on which the Chair of the Commission of the Bureau is confirmed by the Senate.

In floor remarks, Rep. Shelley Moore Capito (R-WV), Chair of the Financial Institutions Subcommittee, said that having a five-member Commission rather than a single Director will strengthen the leadership of the CFPB in two ways. First, a Commission where the individual commissioners are staggered in their terms will provide greater stability by ensuring there is always some form of leadership in the CFPB. Second. a Commission will provide greater consistency, not only in rulemaking, but also from one Administration to another. Rep. Capito feared that a single Director will set up a situation in which the leadership of the CFPB will be subject to the ideology of the current Administration when the director is appointed.