Monday, October 31, 2011

UK Audit Regulator Comments on PCAOB Concept Release on the Audit Report

Commenting on the PCAOB’s Concept Release on the audit report, the Financial Reporting Council, the Board’s counterpart in the UK, said that the audit report cannot be treated in isolation and that attempts to improve the usefulness of the auditor reporting model must begin with improvements to corporate reporting more generally. In addition, the primary responsibility for providing information to investors should rest with the company’s management, said the FRC. The auditor should review that information and supplement or correct it as necessary; but should not be obliged to duplicate management disclosures. The FRC also envisions a key role for the audit committee.

It is the FRC’s view that the primary responsibility for communicating key information on historical performance and future opportunities and risks lies with the company’s directors and executive management. Substantive involvement by the auditor in direct reporting in this area runs the risk that the auditor takes on a management role. For these reasons, the FRC does not believe that the auditor should be responsible for the provision of information on a company’s business strategy or key risks. However, there is scope for the auditor to add greater value in this area.

The FRC proposed that auditors provide a fuller report to audit committees aimed at ensuring that the committee understands fully the factors that the auditors relied upon in exercising their professional judgment in the course of the audit and, in particular, in reaching their audit opinion. These factors are likely to include the effectiveness of the system of control, the materiality judgments made in the audit plan and the implications of those judgments for the level of assurance provided by the audit, and the appropriateness of the accounting policies.

In the FRC’s view, the audit report itself should be expanded to provide a new section on the completeness and reasonableness of the audit committee’s report and the identification of any matters in the annual report that the auditors believe are incorrect or inconsistent with the information contained in the financial statements or obtained in the course of their audit.

Noting that audit committees are well placed to deliver effective governance and oversight of the audit process, the FRC proposed that the audit committee report to the full board, with the report to be included in the annual report, on the approach that it took to the discharge of its duties, describing the key risks, including the choice of accounting policies, that it identified to the integrity of the annual report, including the financial statements, and how it arranged for those to be addressed. The report should also include matters of material significance identified by the audit committee that are not addressed elsewhere in the annual report, and which should be known to users if the annual report, taken as a whole, is to be fair and balanced.

The report should also detail the steps the audit committee took and the judgments it made to assess the effectiveness of the audit. It should explain the policies that the audit committee adopted to avoid the independence of the company's auditors being compromised through the provision of non-audit services and the process by which the committee reached its recommendation to appoint or reappoint the company's external auditors and the reasons for that recommendation. Finally, the report should set out any dialogue that the audit committee may have had with investors in relation to any material audit issues not addressed elsewhere in the report.

PCAOB Moving in Step with International Counterparts to Reform Financial Audit Says Member Harris

Both the PCAOB and its foreign counterparts are considering regulations that could fundamentally change the accounting and auditing profession, said Board Member Steven Harris, all with the goal of improving audit quality, enhancing the public's confidence in financial reporting, and protecting investors. In remarks at the Utah State University 35th Annual Accounting Conference, he noted that European policy makers and audit oversight bodies are considering several ambitious proposals. For example, in the UK, reports have emerged detailing auditors' failure to challenge managements' assumptions, lack of independence, and inadequate disclosures to investors in the lead up to the financial crisis.

Recently, Stephen Haddrill, Chief Executive of the Financial Reporting Council, the PCAOB's counterpart in the UK, questioned the form of the audit report and asked if there is a need to make it more useful with more information being provided in the front of the report about risks, and with the auditor providing greater assurance about risks.

Also, calling the outside audit report on company financial statements a wholly uninformative product of an opaque audit process, the Financial Reporting Council said it would propose an expanded audit report that includes a new section addressing the completeness and reasonableness of the audit committee's report and identifying any matters in the annual report that the auditors believe are incorrect or inconsistent with the information contained in the financial statements or obtained in the course of the audit.

European Commissioner for Internal Market Michel Barnier has also begun an inquiry into the future of the auditing profession. The European Commission has published a Green Paper on audit policy, noted Member Harris, the stated purpose of which is to launch a debate on the role of the auditor, the governance and the independence of audit firms, the supervision of auditors and the international co-operation for the supervision of global audit networks. Since the Green Paper was issued, Commissioner Barnier has suggested audit only firms, mandatory audit rotation, and joint audits for the largest companies. Member Harris noted that the PCAOB is looking at a number of these issues as well including revising the auditor's report, enhancing auditor independence, objectivity and skepticism and improving transparency.

The Board has issued a Concept Release on changing the auditor's reporting model. Generally, noted Member Harris, investors are not looking for more audit work to be performed by auditors but for a public discussion of those things that should be obvious to an auditor following a well-performed audit. At a basic level, he said, investors want auditors to ask themselves what is it that, if they were investing in the company, they would want to know; and for the auditors then to highlight or provide that information. Investors also want to know those issues that came up during the audit and "kept the auditor up at night."

According to Member Harris, possible alternatives for changing the auditor's reporting model, as described in the Concept Release, include an Auditor's Discussion and Analysis; required and expanded use of emphasis paragraphs in the auditor's report; auditor assurance on other information outside the financial statements such as, assurances on Management's Discussion and Analysis, non-GAAP information, and earnings releases; and clarification of language in the standard auditor's report such as, the meaning of reasonable assurance; the auditor's responsibly for fraud; the auditor's responsibility for financial statement disclosure; management's responsibility for the preparation of the financial statements; the auditor's responsibility for information outside the financial statements and auditor independence.

In his view, the issue is how best to provide the information that investors want in a cost effective and efficient way. Because investors are asking for information that auditors already know, he is hopeful that the Board will be able to find a way for that information to be provided in a relatively easy and cost effective manner.
He also noted that investors have made clear to the PCAOB that they do not understand how, during the height of the financial crisis, virtually all companies that received government assistance, or went bankrupt, were given clean audit opinions and investors remain concerned with the lack of progress at the FASB, PCAOB and SEC in modernizing the standards relating to going concern opinions.

The PCAOB is also focused on ways to improve auditor independence, objectivity and professional skepticism, said Member Harris. Over the years, PCAOB inspectors have raised numerous concerns about professional skepticism in their inspections of both large and small firms. Notably, the 2010 inspections have generated more issues than in prior years, with a troubling increase in the volume of significant issues.

He observed that other regulators have found similar problems, with inspection reports from Australia, Canada, Germany, the Netherlands, Singapore, Switzerland and the United Kingdom citing similar deficiencies in professional skepticism as persistent problems at audit firms. The PCAOB issued a Concept Release to solicit public comments on ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms.

Washington State Sets Forth 2012 Renewal Procedure for Investment Advisers

The 2012 renewal process for investment advisers and investment adviser representatives in Washington State involves renewing registrations on the IARD and filing prescribed amendments annually. After November 14, 2011 investment advisers should retrieve their preliminary renewal statement from the IARD; request it from if not received by November 14. Investment advisers are cautioned to pay the $75 IA firm renewal fee and $20 renewal fee for each representative in
as renewal payments not posted on IARD by December 23, 2011 will cause the automatic cancellation of the firm's and representatives' registrations; also, paying in November gives firms ample time to fix errors. However, firms have until before December 12, 2011 if paying by check (or before December 8, 2011 if paying electronically by E-Pay or wire transfer) to pay the total amount due on their preliminary renewal statement. Finally, firms must retrieve and review their final renewal statement from the IARD and pay any outstanding balance between January 3, 2012 and February 3, 2012. Note that February 3, 2012 is the deadline for receipt of final payment and reporting renewal discrepancies.

Firms within 90 days of their fiscal year-end must: (1) electronically file on IARD an annual updating amendment to Part 1 Form ADV; (2) upload onto IARD their annual updating amendment to Part 2 of Form ADV; (3) email their completed Fiscal Year End Report to; and (4) email their Balance Sheet dated as of their most recent fiscal year-end to NOTE: Firms managing a private fund should email a copy of their annual fund audit, if applicable, to within 120 days of their fiscal year-end.

PCAOB Chair Examines Board Broker-Dealer Audit Oversight, Hints that Introducing Brokers May Be Exempted

The PCAOB will use an open and transparent process to develop professional standards and inspection programs to implement Dodd-Frank provisions authorizing Board oversight of firms performing the audits of brokers and dealers registered with the SEC, said PCAOB Chair James Doty. In remarks at the AICPA/SIFMA national conference on the securities industry, the Chair said the Board’s goal is to create programs with real value for investors and customer of broker-dealers, and that reinforce the integrity of the capital markets.

He said that the Board intends to gather information from industry professionals and their auditors so as to act with intelligence and knowledge, not simply on instinct. The information will be obtained through the Board’s temporary inspection program and broker-dealer small business forums, as well as by meetings with representatives of various organizations representing broker-dealers and their auditors, meetings with other regulators, and participation in conferences.

While Dodd-Frank charged the PCAOB with creating an inspection program for the audits of brokers and dealers, the legislation did not mandate a specific program of inspection for these audits, thus giving the PCAOB discretion to determine the specific elements of an inspection program. Recently, the Board adopted and the SEC approved a temporary rule establishing an interim inspection program for auditors of brokers and dealers. Chairman Doty noted that the Board's interim program will be used to learn about the auditors conducting audits of differing types of brokers and dealers.

More specifically, the Board's goal in the interim inspection program will be to gather information that will be used as the basis to inform the Board's consideration of a permanent inspection program. The Board will focus on gaining a greater understanding of the potential benefits to investors and potential cost and regulatory burdens. He stressed that providing programs that add value for investors and account holders means that the benefits of Board programs should exceed the regulatory costs. With this information, the Board will put itself in the best position to determine how to structure the scope of a permanent inspection regime, including whether to differentiate between different classes of brokers and dealers and how frequently auditors should be inspected.

Acknowledging concerns about the scope of the interim program, the PCAOB Chair cautioned the industry not to assume that the inclusive nature of the interim inspection program translates to the likely scope of the permanent program. The Board is not suggesting that every broker or dealer auditor will be inspected as part of the interim program. Indeed, the Board expects to be able to gather most of the information without having to inspect the majority of firms during the interim program.

The Board will consider whether there should be exemptions to the permanent program. While Congress made a deliberate decision not to exempt any class of broker-dealer auditor from Board oversight, noted the Chair, the Board, armed with information gained through the interim inspection program, may be able to focus on areas where oversight would provide the greatest investor protection. In particular, the Board will consider whether to exclude introducing brokers and dealers, which do not generally maintain customer cash and securities, from the permanent inspection program.

The Chair added that, while the risks presented to account holders by the activities of introducing brokers and dealers may be lower than those presented by carrying or clearing brokers and dealers, risks do exist. The interim program, outreach efforts and research have already confirmed that introducing brokers and dealers are not a uniform population. They have a wide variety of business lines and practices, he said, representing varying degrees of risk to their underlying account holders and investors.

Thus, Chairman Doty said that the Board will carefully consider these risks in determining the scope of the permanent inspection program. The PCAOB will also continue to consult with the SEC, FINRA, and the Securities Investor Protection Corporation in order to consider the role of auditor regulation against the backdrop of direct regulation over brokers and dealers.
The interim inspection program will be a key part of gaining understanding of he risks presented by all classes of brokers and dealers against the effectiveness and costs of PCAOB oversight. More broadly, the interim inspection program will provide transparency into what the Board is finding in its interim inspections.

However, unlike the inspection reports of auditors of public companies, the interim inspection program for auditors of brokers and dealers will not initially include firm-specific inspection reports. Instead, the Board will annually publish reports on the interim program and what its inspectors are finding. The Board will not issue firm-specific reports until inspection work is performed under the permanent program, which is not imminent. In fact, Chairman Doty said that decisions about the permanent inspection program are at least a year away. Meanwhile, there will be ample opportunity for the public to learn what the Board is finding in the interim program and to participate in the decision process.

However, the PCAOB Chair emphasized that any significant audit issues identified in the interim program should be promptly addressed by the inspected brokerage firm. In egregious cases, he continued, the Board may initiate disciplinary actions or refer information about potential broker-dealer violations to the SEC or FINRA.
He also noted that PCAOB staff is working on "Day 1 Guidance" to assist auditors in the transition from AICPA to PCAOB standards. This guidance will summarize the requirements of the new attestation and review standards, provide practical implementation guidance, and help auditors gain a greater understanding of the expectations for handling audit and other issues common to brokers and dealers.

On a separate issue, he reminded that the Board's oversight and standards generally do not cover the audit work performed in connection with the client-asset-custody arrangements of investment advisers. These arrangements are governed by SEC rules. While certain investment advisers are required to have reports prepared by auditors registered with the Board, he noted, neither Sarbanes-Oxley nor Dodd-Frank authorizes the Board to exercise oversight over those audits.

In some cases brokers and dealers are also investment advisers, he pointed out, and in some cases investment advisers use particular broker-dealers to maintain custody of their customer assets. In those situations, the Board's oversight responsibilities would extend to the audits of the respective broker-dealer functions. However, the Chair emphasized that the Board is not authorized to directly oversee the audits of investment advisers or their investor protection procedures.

Finally, turning to funding, the Chair said that the largest source of funding for the PCAOB's broker oversight regime comes from the companies whose financial statements must be audited by PCAOB-registered firms. Section 109 of the Sarbanes-Oxley Act, as originally enacted, provided that funds to cover the PCAOB annual budget, less registration and annual fees paid by registered public accounting firms, would be collected from issuers based on each issuer's relative average monthly equity market capitalization. The amount due from issuers is referred to as the accounting support fee.

As amended by the Dodd-Frank Act, Section 109 now requires the Board to allocate respective portions of its accounting support fee among issuers and broker-dealers and allows for differentiation among classes of issuers and brokers and dealers. In establishing rules on the allocation of the accounting support fee between issuers and broker-dealers, the Board was guided by two overarching principles. First, the fee must be allocated in a manner reflecting the proportionate sizes of issuers, brokers and dealers. Second, the fee must be allocated in an equitable manner.

Under the Board's funding rules, brokers and dealers will be allocated a portion of the broker-dealer accounting support fee based on their average, quarterly tentative net capital. Generally, brokers and dealers with average, quarterly tentative net capital of greater than $5 million may be assessed a share of the fee. According to the PCAOB head, this means that the vast majority of broker-dealers will not be assessed any portion of the accounting support fee whatsoever. He added that the Board expects that the initial allocation and assessment of the accounting support fee for brokers and dealers will take place by the end of 2011.

Sunday, October 30, 2011

GAO Report Urges IRS, SEC and CFTC to Develop Information-Sharing Arrangements on Financial Derivatives

Noting that financial derivatives are particularly difficult for the US tax code to timely address, the GAO urged the development of a collaborative information-sharing working relationship between the IRS and the SEC and CFTC. IRS officials told the GAO that they are developing plans to have regular meetings with the SEC to discuss new products and emerging issues related to financial derivatives. The GAO urged the IRS to also develop a working relationship with the CFTC. The GAO report noted that the IRS has occasionally received information from the SEC on financial derivatives that were suspected of being used for abusive tax purposes. Such information, however, is received only on an ad hoc basis, either. through requests initiated by the IRS or referrals from the SEC.

The growth in the complexity and use of financial derivatives presents a particular challenge for the IRS, which sometimes identifies new financial derivative products or new uses for existing products long after they have been introduced into the market. Moreover, the tax code’s current approach to the taxation of financial derivatives is characterized by many experts as the “cubbyhole” approach under which the code establishes broad categories for financial instruments, such as debt, equity, forwards, and options, each with its own rules governing how and when gains and losses are taxed.

As new financial derivatives are developed, the IRS attempt to fit them into existing tax categories by comparing the new instrument to the most closely analogous instruments for which tax rules exist. However, said the GAO, a new financial instrument could be similar to multiple tax categories, and therefore the IRS and taxpayers must choose between alternatives, resulting in inconsistent tax consequences for a transaction that produces the same economic results. Consequently, the IRS is not always able to quickly identify and prevent potential abuse.

The GAO suggested that one way to timely identify new products or new uses of products would be through increased information sharing with the SEC and CFTC, given their oversight role of the financial derivative markets. Similarly, there may also be opportunities for bank regulators to share with the IRS any knowledge of derivatives that they gain. This would be consistent with the IRS’s goal of strengthening partnerships across government to ensure that taxpayers meet their obligations to pay taxes.

The GAO recommended a number of best practice that can inform an IRS-SEC-CFTC working relationship, including defining a common outcome, establishing mutually reinforcing strategies, leveraging resources, establishing cross-agency policies, and setting up joint agency and individual accountability.

Although financial derivatives enable companies and others to manage risks, noted the GAO, some taxpayers have used financial derivatives to take advantage of the current tax system, sometimes in ways that courts have later deemed improper or Congress has disallowed. Without changes to the approach to how financial derivatives are taxed, concluded the GAO, the potential for abuse continues.

Currently, the IRS does not systematically or regularly communicate with the SEC or CFTC on financial derivatives. The IRS’s 2009-2013 Strategic Plan lists strengthening partnerships across government agencies to gather and share additional information as key to enforcing the law in a timely manner to ensure taxpayers meet their obligations to pay taxes. The SEC and CFTC told the GAO that opportunities may exist to share additional information on financial derivatives with the IRS.

However, the ability of the IRS to share taxpayer information with other federal agencies is limited under Section 6103 of the Internal Revenue Code, which governs the confidentiality of taxpayer data. IRS officials say that the lack of reciprocal information sharing is an impediment to effective collaboration with the SEC and CFTC.

SEC officials told the GAO that when potential tax abuses have been identified and shared with the IRS, the SEC examiner involved in the case typically had some tax expertise or had worked with the IRS in the past. For example, in 2008, SEC examiners discovered a strategy employed by hedge funds to structure short-term capital gains into long-term capital gains through the use of options. This information was referred to the IRS because SEC staff believed that the IRS may conclude that the structuring of transactions in this manner may result in an incorrect treatment of capital gains. The IRS said that this information was essential to the eventual development and issuance of related guidance. However, IRS officials also said that SEC and CFTC examiners often do not have tax expertise. As a result, potential tax abuses may not be identified and shared with the IRS.

The IRS typically uncovers new financial derivative abuses during a tax audit, said the GAO, meaning by the time IRS identifies the financial derivative product, and issues guidance, the market for that product can be relatively large and developed. The SEC may identify new products and emerging trends in financial derivatives trading before the IRS because new products on exchanges must be approved by the Commission before they can be traded, and others may be disclosed in financial statements. According to IRS officials, improved collaboration could help the IRS more quickly identify and analyze emerging financial trends and new products in the financial derivatives market before taxpayers even file their tax returns.

The IRS said that a regular avenue for obtaining information about sales reported to the SEC in disclosures of insider trading could have sped the IRS’s identification of the use of VPFCs with share-lending agreements. When taxpayers deferred income recognition by not considering a VPFC and share-lending agreement as constituting a sale on their tax return, some taxpayers reported the transaction as a sale for SEC purposes. IRS officials obtained this information, but had they been regularly and systematically communicating with other agency officials on financial derivatives, problems with these transactions may have been identified earlier.

The IRS believes that because information on financial derivatives may be reported for +both regulatory and tax purposes, reviewing certain types of transactions collaboratively with the SEC and CFTC could help the IRS better identify abuse. For example, the IRS said that information on financial derivatives from SEC Form 4s, which relate to insider trading, and Form 10-Ks have been useful for identifying new financial derivative products and potential tax issues.

Federal banking regulators also have information on financial derivatives. Although federal banking regulators do not oversee derivatives markets, their oversight of banking institutions includes evaluations of risks to bank safety and soundness from derivatives activities. For example, reported the GAO, their oversight captures most credit default swap activity because banks act as dealers in the majority of transactions and because they generally oversee credit default swap dealer banks as part of their ongoing examination programs. Similarly, since OCC-regulated banks may only engage in activities deemed permissible for a national bank, the agency periodically receives requests from banks to approve new financial derivatives activities. Information collected during these reviews may provide the IRS with information on financial derivatives.

Friday, October 28, 2011

Sarbanes-Oxley Whistleblower Provision Not Limited to Allegations of Fraud against Shareholders Says SEC Amicus Brief

The whistleblower provision of the Sarbanes Oxley Act, codified in Section 806, is not limited to allegations of fraud against shareholders or to conduct that is otherwise adverse to the interests of investors, contended the SEC in an amicus brief submitted to the DOL Administrative Review Board. There is nothing in the language of Section 806, said the SEC, indicating that the listed categories of laws and regulations to which an employee’s communication must relate, such as wire fraud, mail fraud and violations of SEC regulations, is qualified by a requirement that it must be related to fraud against shareholders or of a type that would be adverse to investors’ interests. Sylvester v. Parexel International LLC, ARB Case No. 07-123.

The SEC also said that the whistleblower should not have to establish that the protected activity definitively and specifically relates to a violation of one or more of the laws listed in Section 806. Although acknowledging that the Administrative Review Board and most courts require that an employee’s communications definitively and specifically relate to one or more of the federal laws or regulations specified in Section 806, the SEC pointed out that this qualification is not required. If the requirement should be adopted, continued the Commission, it should be interpreted consistent with the remedial purpose of Section 806.

Although the SEC does not favor the use of the phrase “definitively and
specifically,” calling it overly narrow and strict, the Commission agrees with the courts that a certain degree of specificity is required. General inquiries are not enough.

The term “definitively and specifically” appears to have originated in a whistleblower case brought under the Energy Reorganization Act. There, the Sixth Circuit said that to constitute a protected safety report, an employee’s acts must implicate safety definitively and specifically. Am. Nuclear Res., Inc. v. U.S. Dep’t of Labor, 134 F.3d 1292 (6th Cir. 1998). But the Sixth Circuit also emphasized that whistleblower statutes should be interpreted broadly.

According to amicus, the courts that have adopted the definitively and specifically requirement in applying Section 806 have generally interpreted it in a manner consistent with the whistleblower provision’s remedial purpose. Section 806 requires only that the employee’s communication regard.conduct which the employee reasonably believes constitutes a violation of one of the enumerated federal laws or SEC regulations. The SEC does not believe that the qualification that the communication “must relate ‘definitively and specifically’ to” one of those laws should be added.

Although the courts generally have accepted the qualification, said the SEC, they have given it an appropriate interpretation consistent with the remedial purposes of Section 806. The SEC agrees with courts that have focused on the degree to which the communication can be reasonably understood by the employer to implicate a possible violation of one of the enumerated laws. As the Fourth Circuit explained in Welch v. Chao, 536 F.3d 269, 275 (4th Cir. 2008), this requirement ensures that an employee’s communications to his employer are factually specific and identify the specific conduct that the employee believes to be illegal. Beyond that, the SEC does not believe that the employee’s communication needs to include a detailed analysis of the alleged violation in order to be protected activity.

House Legislation Reforming Mortgage Securitization Would Abolish Dodd-Frank Risk Retention Provisions

Legislation introduced by Rep. Scott Garrett (R-NJ) would abolish the Dodd-Frank risk retention provisions as part of a broad reform of the mortgage securitization process. The Private Mortgage Market Investment Act would also direct the Federal Housing Finance Administration, overseer of Fannie Mae and Freddie Mac, to develop standard and uniform securitization agreements and representations and warranties and to streamline the process for securities that meet the standard underwriting characteristics and securitization agreements to be sold to investors. The legislation would also authorize FHFA to ensure underwriting and securitization standardization compliance. Rep. Garrett is the Chair of the House Capital Markets Subcommittee. The subcmmittee will hold hearings on the legislation on November 3.

The legislation would require mandatory arbitration on disagreements between investors and issuers on representations and allow for the appointment of an independent third party to act for the benefit of investors in mortgage-backed securities.

In an effort to enhance transparency and disclosure around securitization of mortgages, the legislation would increase the quality of the loan level information and the disclosures that investors can use to evaluate the value of the mortgages. The measure would also increase transparency by mandating the disclosure of pricing history on securitization deals and requiring the creation of an individualized marker for each loan within a securitization. It would ensure that investors have sufficient time to review and analyze disclosed information before making investment decisions.

Federal Judge Questions SEC-Citigroup Settlement, Asks if Proposed Penalty Is Meaningful Deterrent

A federal judge (SD NY) has questions about the SEC-Citigroup settlement, including why the court should impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing. The judge also asks, given the SEC’s statutory mandate to ensure transparency in the financial marketplace, if there is an overriding public interest in determining whether the SEC’s charges are true, especially when there is no parallel criminal case. More broadly, the court questions how a securities fraud of this nature and magnitude could be the result simply of negligence The court, which is required to ascertain whether the proposed judgment is fair, reasonable, adequate, and in the public interest, has set a November 9 hearing, at which time the parties should be prepared to answer these questions in detail. In addition, the parties are permitted, but not required, to file with the court written answers to these questions in advance of the hearing.

In the enforcement action, the SEC alleged that the principal U.S. broker-dealer subsidiary of the financial institution mislead investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market in which the entity bet against investors as the housing market showed signs of distress. The CDO defaulted within months, leaving investors with losses while Citigroup made $160 million in fees and trading profits. Without admitting or denying the allegations, the financial institution agreed to settle the SEC’s charges by paying a total of $285 million, which will be returned to investors. (SEC v. Citigroup Global Markets, Inc, SD NY, 11-CIV 7387, Rakoff, J).

The court also wants to know the total loss to the victims as a result of the financial institution’s actions and how this was determined. If, as the SEC’s submission states, the loss was at leastlf $160 million, what was it at most. Also, how was the amount of the proposed judgment determined, asked Judge Rakoff, in particular what calculations went into the determination of the $95 million penalty. The court queries why the penalty in this case is less than one-fifth of the $535 million penalty assessed in SEC v. Goldman Sachs & Co No. 10 Civ. 3229 (S.D.N.Y. July 20 2010).

More broadly, the court asks what reason there is to believe that the proposed penalty will have a meaningful deterrent effect. The SEC’s submission states that the Commission has identified nine factors relevant to the assessment of whether to impose penalties against a corporation and, if so, in what amount. But the submission fails to particularize how the factors were applied in this case. The court asks if the Commission employed these factors in this case and, if so, how should this case be analyzed under each of those nine factors.

The proposed judgment imposes injunctive relief against future violations. The court wants to know what the SEC does to maintain compliance and how many contempt proceedings against large financial entities the Commission has brought in the past decade as a result of violations of prior consent judgments. The court also queries why the penalty in this case is to be paid in large part by the financial institution and its shareholders rather than by the culpable individual offenders acting for the corporation. If the SEC was for the most part unable to identify such alleged offenders, why was this. More granularly, the court asks what specific control weaknesses led to the acts alleged in the complaint and how will the proposed remedial undertakings ensure that those acts do not occur again.

Thursday, October 27, 2011

Senator and Congressman Query FSOC on Transfer of Complex Derivatives from Securities Arm to Retail Bank Within Large Financial Institution

In a letter to Treasury Secretary Tim Geithner and other FSOC Members such as the SEC and CFTC, Senator Sherrod Brown (D-OH) and Rep. Brad Miller (D-NC) expressed concern that a large financial institution transferred risky derivatives from its securities trading subsidiary to its FDIC-insured retail bank subsidiary. The derivatives are apparently complex, opaque, and not remotely standardized, noted the lawmakers. The Treasury Secretary is the Chair of the Financial Stability Oversight Council. The lawmakers posed a series of questions about the transaction and asked FSOC and the Secretary to promptly respond.

Senator Brown and Rep. Miller ask if the transfer of the derivatives was reviewed under Section 23A of the Federal Reserve Act, and if not, why not. Section 23A limits transactions between non-bank and bank affiliates to protect the safety and soundness of banks and to avoid effectively subsidizing high-risk transactions with deposit insurance. Because of the favored treatment of derivative contracts in receivership, reasoned the Senator and Rep., it appears highly likely that losses on derivatives would result in losses to insured deposits ultimately borne by taxpayers.

The transaction would avoid the reporting and review threshold of Section 23A, they noted, only if the transfer was of high-quality assets constituting less than ten percent of the retail bank’s capital stock and retained earnings. The reported demand by counterparties that the securities subsidiary transfer the derivatives to the retail bank to avoid a possible requirement to post additional collateral suggests that the derivatives pose substantial risk. The lawmakers ask FSOC if the transfer was treated as an asset purchase of the derivates by the retail bank from the securities trading subsidiary. If so, they want to know if the purchase price in what was obviously not an arm’s-length transaction was used to determine the applicability of Section 23A.

If regulators did review the transfer, either for purposes of approval under section 23A or to determine if such a review was required, the Senator and Congressman want to know if the regulators determined the risk posed by the derivatives. They also want to know if the securities subsidiary and the financial institution made their proprietary models available to regulators to assess that risk. Also, they query if any of the derivatives are credit default swaps on European sovereign debt and, if so, what effect would default on European sovereign debt have on potential liability under the swaps.

Moreover, if the financial institution completed the transaction without reporting under Section 23A, what measures are available to regulators who disagree with the contention that reporting and review under Section 23A was not required. Thinking of possible remedial action, the legislators ask if regulators can require rescission of the transfer and if the transfer of the derivatives to the retail bank would put insured deposits at risk or would the transfer of the derivatives back to the securities trading arm create a systemic risk to the financial system.
Finally, if the transfer was not reported and reviewed under Section 23A based on the financial institution’s own assessment of the transfer, Sen. Brown and Rep. Miller want to know if regulators would allow reporting and review under Section 23A to be an honor system in the future.

SEC Officials Discuss Int’l Securities Regulation Issues at ABA-Hosted Seminar

At a forum hosted by the American Bar Association, senior SEC officials discussed a number of issues around international securities regulation, including regulatory arbitrage, the Dodd-Frank conflict minerals provisions, the Supreme Court’s Morrison ruling and the SEC study on the extraterritorial reach of the federal securities laws mandated by Dodd-Frank.

Elizabeth Jacobs, Deputy Director, Office of International Affairs, said that a major issue in the international context is trying to avoid an outbreak of regulatory arbitrage. While there is no perfect antidote, said the official, there are a number of tools regulators can use to avoid or limit regulatory arbitrage. One such tool is transparency on a number of levels, including the provision of information to investors so they can make better investment decisions and the exchange of information among regulators, as well as a process by which regulators can obtain useful information to assist them with rulemaking.

Another tool to avoid regulatory arbitrage is cross-border bi-lateral meetings between regulators to engage in the informal exchange of views. As an example, Ms. Jacobs mentioned the recent meeting between the SEC and the UK Financial Services Authority. MOUs and colleges of supervisors are also useful cooperative mechanism tools. Indeed, the Deputy Director sees a consensus of cooperation among regulators as they try to build frameworks for the discussion of issues such as confidentiality. She also noted that the Financial Stability Board has a key role to play in ensuring consistent cross-border financial regulation. She emphasized that Congress is watching these issues very carefully.

On cross-border derivatives regulation, Deputy Director Jacobs noted that the G-20 leaders, in a communiqué issued at the end of the 2009 Pittsburgh Summit, emphasized that all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012 at the latest. Also, OTC derivative contracts should be reported to trade repositories and non-centrally cleared contracts should be subject to higher capital requirements.

The SEC official stressed that national authorities must engage with each other in the area of derivatives regulation. She also mentioned that toward the end of 2011, the SEC and CFTC will deal holistically with derivatives regulation.

Lona Nallengara, Deputy Director, Division of Corporation Finance, spoke about SEC regulations implementing the conflict minerals provisions of Dodd-Frank, noting that final regulations in this area should be adopted by the end of the year. Section 1502 requires companies to disclose the origin of minerals purchased from the Democratic Republic of Congo and establish transparency and accountability in the mineral supply chain to help ensure that conflict minerals are not purchased by companies in the United States or abroad.
The Commission official noted that the recent SEC Roundtable on conflict minerals provided very valuable input that will inform the rulemaking as the staff works to complete the regulations. In particular, the staff received valuable information on tracking the supply chain, reporting and due diligence.

Paul Dudek, Chief of Office of International Corporate Finance, said that this year over 200 foreign private issuers will use IFRS and that this number will double next year as Canadian companies come under an IFRS regime. He also mentioned the guidance issued by the Corporation Finance staff on reverse mergers, noting that this guidance could also be applied to shell companies.

In the area of cyber security, the senior SEC official asked issuers to think about how to discuss cyber incidents under federal securities law disclosure duties. Issues that should be considered for disclosure in SEC filings would include remediation, protection costs, and/or reputational damage. In addition, any discussion of risk factors should be more than boilerplate.

Eric Pan, an Academic Fellow in the Office of International Affairs, discussed the US Supreme Court’s Morrison opinion and the SEC study mandated by the Dodd-Frank Act on the extraterritorial reach of US securities laws, particularly the antifraud rule. The classic conduct and effects test was used by the lower federal courts in the Morrison case, he noted, but the Supreme Court took a different approach and ruled that Exchange Act antifraud provisions do not apply to transactions outside the US. The Supreme Court effectively replaced the conduct and effects test with a transactional test and imposed a bright line rule on the cross-border availability of Rule 10b-5.

In Morrison v. National Australia Bank, Ltd, the Supreme Court ruled that Rule 10b-5 does not provide a cause of action to foreign plaintiffs suing foreign and US defendants for misconduct in connection with securities traded on foreign exchanges since the antifraud rule reaches the use of a manipulative or deceptive device only in connection with the purchase or sale of a security listed on a US exchange, and the purchase or sale of any other security in the US.

Professor Pan noted that there have been approximately 37 post-Morrison federal court opinions interpreting the new test. In most of these cases, he noted, the defendants won, leading to the conclusion that the transactional test has made it more difficult to bring extraterritorial Rule 10b5 claims. In general, the SEC has not gotten involved in these cases by, for example, filing an amicus brief.

Section 929Y of the Dodd-Frank Act directed the SEC to conduct a study and make recommendations on the extent to which private rights of action under the antifraud provisions of the Exchange Act should be extended to cover transnational securities fraud. The SEC has received 64 comment letters on the study, noted the SEC Fellow, and has been hosting visits from groups to discuss their views.

He said that it is unlikely that the SEC staff will make a single recommendation in this area. Rather, the staff study will lay out a number of options for Congress to consider. The study will include an analysis of recent case law and set forth policy questions for Congress to consider. More broadly, the study will pose the question of whether the Supreme Court’s transactional test is good for the US capital markets.

The study will also examine international comity issues with full awareness of the international concerns over the impact of extraterritorial extension of Rule 10b-5. Even more broadly, the study will examine the issue of what is the value add of private rights of action as a supplement to SEC enforcement actions.

SEC Orders FINRA to Improve Internal Compliance Policies and Procedures

Citing weaknesses in the Financial Industry Regulatory Authority’s training, policies and procedures, the SEC ordered FINRA to hire an independent consultant and undertake other remedial measures to improve its document production during SEC inspections.

As charged, the director of FINRA’s Kansas City office caused the alteration of three records of staff meeting minutes just hours before producing them to the SEC inspection staff, making the documents inaccurate and incomplete.

According to the Commission, this matter was the third instance during an eight-year period in which a FINRA employee, or an employee of its predecessor, the National Association of Securities Dealers, Inc., provided altered or misleading documents to the Commission. Although FINRA has endeavored to improve its procedures and training since document integrity issues came to light in May 2006 and December 2007, stated the SEC order, "those efforts were not effective in preventing the Director’s misconduct."

In July 28, 2008, FINRA’s Kansas City District Office received a document request from the Commission inspection staff. As alleged, the district director caused the minutes for three staff meetings to be altered by deleting or editing information, or removing or changing entire passages. With respect to all three altered documents, according to the SEC, the original author’s signature was changed to that of the director.

As a result of this conduct, the SEC found that FINRA violated Section 17(a)(1) of the Exchange Act and Exchange Act Rule 17a-1. Section 17(a)(1) of the Exchange Act requires a national securities association such as FINRA to make and keep for prescribed periods such records, and to furnish copies as required by rule. Exchange Act Rule 17a-1(a) requires a national securities association to keep and preserve at least one copy of all correspondence, records, and other documents made or received by it in the course of its business as such and in the conduct of its self-regulatory activity. Rule 17a-1(c) requires a national securities association promptly to furnish the Commission with a copy of any such document that the Commission requests. The requirement that a national securities association keep and furnish records to the Commission includes the requirement that those records be complete and accurate.

In determining to accept FINRA's settlement offer, the Commission considered remedial acts promptly undertaken by the SRO and the cooperation afforded the Commission staff.

FINRA agreed to several training undertakings, and will engage an independent consultant to review and make recommendations concerning FINRA’s policies and procedures and training relating to document integrity.

The SEC's order may be found

Washington State Provides Notice on IA Switch to State Registration

A notice about the investment adviser switch from SEC to state registration in Washington State is provided by the Department of Financial Institutions.

Wednesday, October 26, 2011

Legislation Allowing General Solicitation under SEC Rule 506 of Reg D Approved by House Financial Services Committee

Legislation removing the general solicitation prohibition in SEC Rule 506 under Regulation D and allowing small businesses to attract capital from accredited investors nationwide and globally has been approved by the full Financial Services Committee and sent to the House floor. The Access to Capital for Job Creators Act, HR 2940, would thereby remove the regulatory ban that prevents small, privately held companies from using advertisements to solicit investors. The legislation was approved by a voice vote, with no amendments offered.

Currently, the SEC regulation allows companies to raise capital as long as they do not market their securities through general solicitations or advertising. This prohibition has been interpreted to mean that potential investors must have an existing relationship with the company. In the view of Committee Chairman Spencer Bachus, requiring potential investors to have an existing relationship with the company unnecessarily limits the pool of investors and severely restricts the ability of small companies to raise capital. HR 2940 would require the SEC to revise its rules to permit general solicitation in offerings under Rule 506 of Regulation D. The legislation mandates that the revised SEC rules allowing a general solicitation under Regulation D must require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors using methods determined by the Commission

HR 2940 is sponsored by Rep. Kevin McCarthy (R-CA), who said that restrictions on the manner in which capital may be raised stem from Depression-era regulations that are clearly outdated, they not only predate Twitter and Facebook, he said, but cell phones and color television. According to Rep. McCarthy, this specific regulatory obstacle, Rule 506 of Regulation D, is actively preventing job creation, which is why he introduced legislation to repeal what the lawmaker called ``this burdensome solicitation prohibition.’’ In his view, the Access to Capital for Job Creators Act will help entrepreneurs and small business owners access the capital they need to be innovative, dynamic, and ultimately, help create jobs.

House Financial Services Committee Reports Out Legislation Raising 500-Shareholder Limit

The full House Financial Services Committee has approved by voice vote and sent to the House floor two pieces of legislation increasing the number of investors permitted to hold shares in either a company or a community bank before the organization is required to register with the SEC or “go public.” Currently, both banks and private companies are subject to a 500 investor threshold, which limits the amount of capital they can raise before they must comply with the reporting requirements associated with SEC registration. Both pieces of legislation would modify Section 12(g) of the Securities Exchange Act.

The Private Company Flexibility and Growth Act (H.R. 2167), sponsored by Rep. David Schweikert (R-AZ), increases the number of shareholders that can invest in a private company from 500 to 1,000. It also exempts employees from that count. H.R. 1965, sponsored by Rep. Jim Himes (D-Conn), increases the number of shareholders permitted to invest in a community bank from 500 to 2,000. HR 1965 updates the federal securities laws to ensure that smaller community banks are not required to register with the SEC and comply with burdensome reporting requirements that are intended for larger corporations.

HR 2167 would amend Section 12(g) of the Exchange Act to trigger SEC reporting at 1000 shareholders held of record and the definition of held of record would not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of section 5 of the Securities Act.

As introduced, the Private Company Flexibility and Growth Act would have exempted accredited investors from the held of record shareholder count as well as employees. But accredited investors were stripped from the legislation during an earlier subcommittee markup pursuant to an amendment introduced by Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee. The amendment was approved by voice vote and left undisturbed by the full Committee.

An amendment offered by Rep. Schweikert raising the trigger from 1000 to 2000 shareholders was withdrawn at the request of Committee Chair Spencer Bachus (R-ALA), who said that passage of the amendment could destroy the carefully constructed bi-partisan support that HR 2167 currently enjoys. Rep. Himes noted that the threshold could be set at 2000 shareholders in his legislation because HR 1965 deals with heavily regulated financial institutions.

HR 2167 directs the SEC to revise the definition of ``held of record’’ pursuant to section 12(g)(5) of the Exchange Act to implement these changes. The Commission must also adopt safe harbor provisions that issuers can follow when determining whether holders of their securities received the securities pursuant to employee compensation plans in exempt transactions. Rep. Melvin Watt (D-NC) questioned whether the ``can’’ should be changed to ``must’’ in the legislative language, meaning an issuer qualifying for the safe harbor would be required to use it, and there seemed to be general agreement in the Committee that it should be changed to ``must’’ before HR 2967 reaches the House floor

Enacted in 1964, Section 12(g) of the Exchange Act requires companies with more than $10 million in assets whose securities are held by more than 500 owners to file annual and other periodic reports with the SEC, which reports are then available to the public through the SEC's EDGAR database. While the $10 million threshold has been incrementally increased over the years from the $1 million level initially set in 1964, the 500 shareholder requirement has never been updated.

In recent testimony before the House Oversight and Government Reform Committee, SEC Chair Schapiro noted that, shortly after the enactment of Section 12(g), the Commission adopted rules defining the terms held of record and total assets. The definition of “held of record” counts as holders of record only persons identified as owners on records of security holders maintained by the company in accordance with accepted practice. The Chair explained that the Commission used this definition to simplify the process of determining the applicability of Section 12(g) by allowing a company to look to the holders of its securities as shown on records maintained by it or on its behalf, such as records maintained by the company’s transfer agent.

But Chairman Schapiro observed that the securities markets have changed significantly since the enactment of Section 12(g). Also, since the definition of “held of record” was put into place, a fundamental shift has occurred in how securities are held in the United States. Today, the vast majority of securities of public companies are held in nominee or street name. This means that brokers that purchase securities on behalf of investors typically are listed as the holders of record. One broker may own a large position in a company on behalf of thousands of beneficial owners, she noted, but since the shares are all held in street name they are counted as being owned by one holder of record.

The SEC Chair added that a staff review of the 500-shareholder test is front and center on the Commission’s agenda. Chairman Schapiro emphasized that the Commission is absolutely committed to seeing if the 500-shareholder limit still makes sense and intends to do a thorough and rigorous analysis of this threshold. In testimony she noted that the review will require the gathering of economic data and analysis because the SEC needs to understand the characteristics of these companies and how their shareholders hold, whether in record name or in the name of the beneficial owner.

House Financial Services Committee Approves Crowdfunding Legislation with Added Investor Protections and Agreement to Preserve State Authority

With strong bi-partisan support building for crowdfunding legislation and the President calling for this form or capital raising, the full House Financial Services Committee approved legislation sanctioning crowdfunding to finance new businesses by allowing companies to accept and pool donations of up to $1 million, or $2 million in some cases, without registering with the SEC. Crowdfunding is an innovative and lower-risk form of financing that enables several individuals to pool money to invest in a particular company. Crowdfunding describes a form of capital raising whereby groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal.

The Entrepreneurial Access to Capital Act, HR 2930, was approved by a bipartisan voice vote as an amendment in the nature of a substitute by sponsor of the legislation Rep. Patrick McHenry (R-NC) that added a number of investor protections to the original bill. In addition, the legislation moved forward based on an agreement by Rep. McHenry and Rep. Ed Perlmutter (D-CO) to work in good faith on amendatory language preserving the authority of state regulators.

The Perlmutter Amendment, which would have struck out the provision on state pre-emption, was withdrawn so that he and Rep. McHenry can work out language preserving state authority, which would be inserted into the legislation before it goes to the House floor for a vote. Rep. McHenry said that the goal is to preserve state oversight authority while allowing capital formation across state lines through crowdfunding. Rep. Melvin Watt (D-NC) sought and received assurance that HR 2930 will not go to the House floor without an amendment preserving state authority. Similarly, Rep. Maxine Waters (D-CA) said that she could support the legislation if it comes to the House floor with such an amendment.

The Committee approved by voice vote an amendment proposed by Rep. Al Green (D-TX) that would preclude persons convicted of a violation of federal or state securities laws or subject to disqualification from such laws from participating in the crowdfunding exemption. Similarly approved was an amendment offered by Rep. Carolyn Maloney (R-NY) that would require notice of the issuance to state securities regulators.

In introducing her amendment, which passed by voice vote, Rep. Maloney said that, without notice, state authorities could not be certain of the address or the status of an issuer. Notice of who they are, where they are and what they intend to sell, she noted, would help states to police this area. Rep. McHenry expressed support for the amendment. Ms. Maloney added that state authorities must have the ability to go after fraud, and the bill as amended does not supersede state enforcement actions against fraud.

Originally, HR 2930 would have provided a crowdfunding exemption to SEC registration requirements for firms raising up to $5 million, with individual investments limited to $10,000 or 10 percent of an investor’s income. An amendment by Rep. Steve Stivers (R-OH), approved by voice vote, lowered the $5 million threshold to $1 million, or $2 million if you have audited financial statements. Noting that crowdfunding is not the sole source of finding for startups, but only the first round, Rep. Maloney supported the Stivers Amendment lowering the amount from $5 million to $1 million.

The legislation is designed to provide smaller investors an opportunity to support startup companies that is currently not an option under SEC regulation. Rep. McHenry (R-NC) noted that new ideas are needed to help provide small businesses and entrepreneurs with the ability to create jobs. HR 2930 creates an exemption from SEC registration for crowdfunding. The legislation is similar to proposals advanced by the Obama Administration. Rep. Maloney noted that the legislation, as amended, is consistent with the President’s proposal.

Separately, Committee Chairman Spencer Bachus (R-ALA) has urged the Joint Select Committee on Deficit Reduction to consider HR 2930 as one way to reduce the deficit by enhancing economic growth.

FASB Chair Supports SEC Staff Condorsement Framework as Way to Move Forward on IFRS Adoption

The condorsement framework for the adoption of IFRS advanced by the SEC staff demonstrates U.S. support for the ongoing development of global accounting standards and adopts the very practical approach of retaining the label “U.S. GAAP,” said FASB Chair Leslie Seidman. Regardless of the way IFRS is brought into the U.S., reasoned the FASB Chair, it is easier on the system if it is called U.S. GAAP for federal and state legislative and regulatory purposes and contractual covenants.

The framework suggested by the SEC staff envisions the gradual implementation of IFRS into the US financial reporting system, blending the existing onvergence and endorsement approaches into what the staff calls ``condorsement.’’ The transition to IFRS under the framework would occur on a staggered basis over a number of years and be coordinated with the ongoing standard-setting activities of the IASB.

In remarks to the Nat’l Assoc. of State Boards of Accountancy, the FASB Chair noted that condorsement calls for some level of U.S. involvement in the establishment of any new standards. After reviewing the comment letters that have come into the SEC, the Chair concluded that most people feel very strongly that they want to continue to have active participation in the process themselves, as stakeholders, but also believe that the FASB should continue to have a strong role in influencing what goes on the international agenda, the process by which these issues are analyzed, the level of implementation guidance provided, and the outreach that is conducted in the U.S.

This is an acknowledgment that to have a global standard that the U.S. follows, she added, it has to work in the US environment. Chairman Seidman believes that there are other countries around the world that also would seek substantive roles for their national standard setter in the process, such as Japan. There is a way to leverage the national processes and resources that exist, she noted, and with proper coordination bring them to the development of international standards.

Condorsement also recognizes that there should be a gradual approach to dealing with the remaining differences between U.S. GAAP and IFRS. The US is in a very different position than a lot of other countries that have gone through this endeavor, observed the FASB chief, and there is a need to go through a thoughtful exercise to look at those differences and determine the best course of action for the U.S.

For example, sometimes, FASB has a standard and the IASB does not. Rate regulation is one important example. In the FASB Chair’s opinion, it would be preferable to keep U.S. GAAP in those cases until an appropriate international standard has been set.

There are other important remaining differences between U.S. GAAP and IFRS, but they are not all of the same nature or magnitude For example, the difference between U.S. GAAP and IFRS on Research and Development is a core issue for some companies and their investors. This difference must be addressed, emphasized the Chair. Likewise on recycling amounts out of other comprehensive income to net income, U.S. GAAP does and IFRS usually does not. This is a very important issue to investors, said the FASB Chair. On impairment losses for hard assets, she continued, IFRS reverses if a recovery occurs; U.S. GAAP does not. This is an important difference that must be resolved.

Some other differences seem less important from a decision-making standpoint. For example, the Chair asks if it really affects an investment decision if the US depreciate things differently. If not, it might not be worth the systems costs of doing the conversion, at least not as a high priority item.

Tuesday, October 25, 2011

South Dakota Adopts Amendment to IA Private Adviser Exemption

The exemption from South Dakota registration requirements for certain investment advisers meeting the conditions of Sections 203(b) and 203(l) of the Investment Advisers Act of 1940 was amended to permit the exemption for certain investment advisers meeting the conditions of Sections 203(b), (l) or (m) of the 1940 Act, effective October 24, 2011.

The Section 203(b) exemption known as the "private adviser" exemption contains a "de minimis" exemption at Section 203(b)(3) for investment advisers that, during the preceding 12-month period, had fewer than 15 clients and neither held themselves out generally to the public as an investment adviser nor acted as an investment adviser to any investment company registered under the Investment Company Act of 1940, or is a company that elected to be a business development company under Section 54 of the Investment Advisers Act of 1940. The Section 203(b)(3) exemption, previously relied on by advisers to hedge and other private funds, was repealed and replaced by the new exemptions at Sections 203(l) and (m).

The Section 203(l) exemption is for advisers that advise only one or more "venture capital funds." The Section 203(m) exemption, the new addition to South Dakota's private adviser exemption, instructs the SEC to exempt investment advisers that act solely as advisers to private funds and have assets under managment in the U.S. of less than $150 million.

Senators Franken and Wicker Urge SEC to Implement Their Amendment to Reduce Conflict of Interest in Assigned Credit Ratings

In a letter to the SEC, Senators Al Franken (D-MN) and Roger Wicker (R-MS) urged the Commission to implement the Franken-Wicker Amendment on assigned credit ratings. The current issuer-pays model and its inherent conflicts of interest is flawed and makes true competition in this credit rating industry nearly impossible, said the Senators. A system, in which issuers are pursuing the highest rating possible but are also the source of revenue for ratings agencies, created a market in which accuracy was discouraged and competition was stifled.

While Dodd-Frank and the Credit Rating Agency Reform Act both gave the SEC as yet underutilized authority to address conflicts of interest, noted the Senators, the Franken-Wicker Amendment is the only proposal included in the Dodd-Frank Act that gets at the root of the problem of the inherent conflicts of interest in the issuer-pays system. The Franken-Wicker Amendment would reduce the conflicts of interest, eliminate ratings shopping for initial ratings, encourage the market to reward accuracy, and promote competition and thereby fundamentally reform the industry and break up its oligopoly, while seeking to preserve the credit rating industry. Once the market is functioning properly, incentives will be aligned to promote quality ratings and increase competition.

According to Senators Franken and Wicker, their Amendment provides a simple solution by creating an independent, self-regulatory board to administer a system in which issuers are assigned a credit rating agency to provide an initial rating. NRSROs could opt-in in to this system, and apply to become a qualified NRSRO (QNRSRO), which would allow them to participate in the assignment process. The process would not be random, emphasized the Senators, since the board could consider institutional capacity, expertise, and track record in developing its assignment system.

For example, the board could determine that a certain set of QNRSROs are qualified to rate a particular subset of securities, and another set of QNRSROs are qualified to rate a different subset. The board would not randomly assign a large, complex, sophisticated structured finance product to a newly registered ratings agency with limited expertise for that type of product. The Amendment also permits a selected NRSRO to refuse to rate a product. Also, the Franken-Wicker Amendment does not affirmatively prescribe the criteria that should be used in its assignment system, but does prohibit issuer preference as one of those criteria.

The majority of the new self-regulatory board would be comprised of investors, but would also include representatives from the credit rating industry, the issuer community, and at least one independent member. While the initial members of the board would be selected by the SEC, the board would eventually develop a selection process for subsequent members. To promote transparency, the Franken-Wicker Amendment requires that the board publish its assignment methodology.

The Senators emphasized that the Amendment would apply only to initial ratings, would not affect non-initial ratings or unsolicited ratings. Also, citing evidence suggesting that oversight is most needed in the structured finance sector, they noted that, under the Franken-Wicker Amendment, the board’s rating agency assignment process is mandatory only in the structured finance sector. Also, the Amendment would have no effect on the government or corporate bond market.

A little-noticed provision in the Franken-Wicker Amendment instructs the board to issue a report to Congress within five years of beginning to assign ratings, with its recommendations regarding the continuation of the board, and modifications to the procedures of the board or provisions in the authorizing language. According to Senators Franken and Wicker, this provision recognizes that the industry may shift in a way that necessitates fundamental changes in the board's operations, or the discontinuation of the board itself.

Under the Franken-Wicker Amendment, the board would have the authority to intervene if credit rating agencies were charging unreasonably high fees for initial ratings compared with fees it charged for similar products outside the assignment process. But the Senators anticipate that the grant of authority to the board to ensure reasonable fees will go largely unutilized, because of the market indicators readily available, and because of the increased competition that will result from the assignment process system.

The Franken-Wicker Amendment does not prescribe a structure in which the board serves as an intermediary for the collection and distribution of fees. The board's assignment system is intended to eliminate direct conflicts of interest and ratings shopping, reasoned the Senators, and it can accomplish this objective without becoming a fee intermediary.

The Franken-Wicker Amendment calls for the levy of fees from QNRSROs to fund the operation of the board. While this option strikes the Senators as the most straightforward, they are open to the idea that a fee-sharing scheme among the rating agencies, issuers, and investors might also be formulated in a way to fairly distribute costs.

Finally, the Franken-Wicker Amendment makes clear that a rating received through the assignment system has not been approved or certified by the US Government or by a federal agency.

Implementing Pension Protection Act Exemption, DOL Regulation Allows Fiduciary Investment Advisers to Advise 401(k) Participants

Implementing a prohibited transaction exemption under changes to ERISA and the Internal Revenue Code provided by the Pension Protection Act, the Department of Labor adopted Regulation 408g-1 allowing fiduciary investment adviser to provide advice to participants in 401(k) plans. The prohibited transaction rules in ERISA and the IRC generally prevent a fiduciary investment adviser from recommending plan investment options if the adviser receives additional fees from the investment providers. Although these rules protect participants from conflicts of interest, ERISA provides exemptions from the rules in appropriate circumstances and permits DOL to grant exemptions that have participant-protective conditions. The new regulation implements an exemption that Congress enacted as part of the Pension Protection Act to improve participant access to fiduciary investment advice, which contains certain safeguards and conditions to prevent investment advisers from providing biased advice that is not in a participant's best interest

This regulation is separate from and does not affect the Labor Department's proposed rule on the definition of fiduciary investment advice, which the department recently announced that it will re-propose.
To qualify for the exemption in the final regulation, investment advice must be given through the use of a computer model that is certified as unbiased by an independent expert or through an adviser compensated on a level-fee basis, meaning that the fees do not vary based on investments selected. Both types of arrangements must also satisfy several other conditions, including the disclosure of the adviser's fees and an annual audit of the arrangement for compliance with the regulation.

The exemption is conditioned on no fiduciary adviser that provides investment advice receiving from any party any fee or other compensation, including commissions, salary, bonuses, awards, promotions, or other things of value, that varies depending on the basis of a participant's selection of a particular investment option. Consistent with the statute, this provision proscribes the receipt of fees or compensation that vary based on investment options selected, and therefore could have the effect of creating an incentive for a fiduciary adviser to favor certain investments.

The Department intends for this fee-leveling requirement to be broadly applied in order to ensure that the objectivity of the investment advice recommendations to plan participants is not compromised by the advice provider's own financial interest in the outcome. For purposes of applying the provision, the Department would consider things of value to include trips, gifts and other things that, while having a value, are not given in the form of cash. Accordingly, almost every form of remuneration that takes into account the investments selected by participants and beneficiaries would likely violate the fee-leveling requirement of the final rule. On the other hand, a compensation or bonus arrangement that is based on the overall profitability of an organization may be permissible if the individual account plan and IRA investment advice and investment option components are excluded from, or constituted a negligible portion of, the calculation of the organization's profitability.

The Department believes, however, that whether any particular salary, bonus, awards,promotions or commissions program meets or fails the fee-leveling requirement ultimately depends on the details of the program. In this regard, the Department noted that the details of such programs will be the subject of both a review and a report by an independent auditor as a condition for relief under the statutory exemption.

The fiduciary adviser must annually engage an independent auditor with appropriate technical training or experience and proficiency to conduct an audit of the adviser's investment advice arrangements for compliance with the regulation. Within 60 days following completion of the audit, the auditor must issue a written report to the fiduciary adviser and, except with respect to an arrangement with an IRA, to each fiduciary who authorized the use of the investment advice arrangement. The written audit report must set forth the specific findings of the auditor regarding compliance of the arrangement with the regulation.

The regulation mandates certain basic information about the audited arrangement that must be included in the audit report. Specifically, the report must identify the fiduciary adviser and the type of arrangement. Further, if the arrangement uses computer models, or both computer models and fee leveling, the report must also indicate the date of the most recent computer model certification, and identify the eligible investment expert that provided the certification.

If the audit report identifies noncompliance with the regulation, then the fiduciary adviser must send a copy of the report to the Department of Labor within 30 days following receipt of the report from the auditor. This report will enable the Department to monitor compliance with the regulation.

Texas Proposes IA Custody Rule and Amendments to Advisory Fee and Written Exam Rules

A safekeeping rule for investment advisers with custody of their clients’ funds or securities was proposed by the Texas Securities Board, together with amendments to an advisory performance based fees rule and to the written examination rules for dealer principals, agents, investment advisers and investment adviser representatives. The "solicitor" definition would be clarified.

Monday, October 24, 2011

European Commission Proposes Derivatives Regulatory Regime by Revising MiFID and Adopting EMIR

The European Commission has proposed a regulatory regime for derivatives under which all trading of derivatives which are eligible for clearing and which are sufficiently liquid will move to either regulated markets, multilateral trading facilities, or to new organized trading facilities. The Commission also proposes to give harmonized and comprehensive powers to financial regulators to monitor and intervene at any stage in trading activity in all commodity derivatives, including in the shape of position limits if there are concerns in terms of market integrity or orderly functioning of markets. Venues offering trading in commodity derivatives will also be required to adopt suitable limits on trading activity by traders active on their platform, to safeguard market integrity and efficiency, to be harmonized in implementing measures. The proposals applicable to other derivatives regarding increasing pre- and post-trade transparency and mandatory trading on organized venues will also apply to commodity derivatives.

The proposals will be effected through revision of the Markets in Financial Instruments Directive MiFID and adoption of a new European Markets Infrastructure Regulation (EMIR). The proposals now go to the European Parliament and the Council for negotiation and adoption. Once adopted, the Regulation and the Directive will apply together as of the same date.

Under the proposals, fewer commodity firms will be exempt from MiFID when they deal on their own account in financial instruments or provide investment services in commodity derivatives on an ancillary basis as part of their main business and when they are not subsidiaries of financial groups. It is proposed to narrow down existing exemptions in the interests of greater regulatory oversight and transparency, taking into account the need for continued exemptions for commercial firms and the risks posed by these players.

The Commission is acting through a Directive and a Regulation due to the need to achieve a uniform set of rules in some areas, while allowing for national specificities in others. The De Larosière report highlighted that one of the problems leading to the financial crisis was an inconsistent implementation of financial services rules leading to a fragmented internal market. The Commission believes that the harmonized approach embodied in the proposed Regulation will help avoid confusion in the daily functioning of markets, and minimize opportunities for harmful regulatory arbitrage between Member States.

The proposed Regulation sets out requirements on the disclosure of data on trading activity to the public and transaction data to regulators, the mandatory trading of derivatives on organized venues; removing barriers between trading venues and providers of clearing services to ensure more competition, and specific regulatory actions regarding financial instruments and positions in derivatives.

The Directive would amend existing provisions on authorization and organizational requirements for providers of investment services, and all rules regarding investor protection, including for firms located in third countries but actively engaged in EU markets. Also included in the Directive are the authorization and organizational rules applicable to different types of trading venue, providers of market data and other reporting services, as well as the complete powers to be granted by Member States to national authorities, including the framework of sanctions for breaches of the rules. These provisions are best situated in a Directive to account for differences in national markets and legal structures as well as the profile of local investors.

Like the Dodd-Frank Act, the revision of MiFID would both amend provisions already in force and add to them in light of the financial crisis and other market developments. The most visible area of common ground concerns the overhaul of the regulation of derivative markets, including commodity derivatives. In many areas, such as comprehensive regulation for professional participants in derivative markets and the regulation of alternative electronic exchanges, the changes in MiFID are less significant than those in the US, as similar provisions did not yet exist before the Dodd-Frank Act. In other areas, such as the regulation of commodity derivative markets, US regulation was more developed and the revision of MiFID allows Europe to catch up.

Currently the access of third country firms to the EU markets is not harmonized under MiFID. Each Member State can introduce its own third country regime, provided that national provisions do not result in treatment more favorable than that given to EU firms. In order to overcome the existing fragmentation and to ensure a level playing field in the EU for third country players, the Commission proposes to introduce a harmonized third country equivalence regime in MiFID for the access of third country investment firms and market operators to the EU.
A firm which is authorized in a third country will be able to provide services directly to professional investors on condition that the country where it is based is deemed by the Commission to have equivalent rules and supervision. Also, equivalence will be granted only if the third country provides access to EU-based firms on a reciprocal basis.

In order to be allowed to provide services to retail investors, the establishment of a branch is required. A third country firm will be able to provide services to investors in other European countries from its branch, provided that it notifies the regulators in those countries.

The proposals envision a significant role in the new regime for the European Securities and Markets Authority (ESMA). For example, ESMA will decide when a derivative which is eligible for clearing is sufficiently liquid to be traded exclusively on the various organized venues, such as regulated markets, MTFs or organized trading facilities. Appropriate criteria for such assessment will need to be taken into consideration by ESMA. Moreover, in coordination with ESMA and under defined circumstances, regulators will be able to ban specific products or services in case of threats to investor protection, financial stability or the orderly functioning of markets.

The proposals also foresee stronger regulation of commodity derivatives markets. It introduces a position reporting obligation by category of trader. This will help regulators and market participants to better assess the role of speculation in these markets. In addition, the Commission proposes to empower financial regulators to monitor and intervene at any stage in trading activity in all commodity derivatives, including in the shape of position limits if there are concerns about disorderly markets. The G-20 Summit in Cannes in early November will also address the issue of commodity derivatives

Building on a comprehensive set of rules already in place, the revised MiFID sets stricter requirements for portfolio management, investment advice and the offer of complex financial products such as structured products. In order to prevent potential conflicts of interest, independent advisors and portfolio managers will be prohibited from making or receiving third-party payments or other monetary gains. Finally, rules on corporate governance and managers' responsibility are introduced for all investment firms.

Sunday, October 23, 2011

Former Fed Chair Volcker Calls On Congress and the Regulators to Complete Financial Market Reforms, Comments on UK Vickers Report

Former Fed Chair Paul Volcker called on Congress and the federal financial regulators to complete reform of the financial system by regulating money market funds that choose to offer bank-like services and redemption of investments at par, adopting international accounting standards, and requiring the rotation of outside auditors of company financial statements in order to achieve true auditor independence. In remarks at a G-30 co-hosted lecture series, the former Fed Chair also urged regulators and policy makers to finalize policies to end “too big to fail’’ by following through on a meaningful Volcker Rule, ensuring that a strong, clear resolution authority is in place for non-banks, and engaging international financial centers to establish consistent resolution policies. In his view, a practical resolution authority, widely agreed internationally, will be the keystone in a stronger international financial system. Mr. Volcker is Chairman of the G-30 Board of Trustees.

Mr. Volcker emphasized that Dodd-Frank’s prohibitions on proprietary trading and strong limits on sponsorship of hedge funds and private equity funds are important steps to deal with risk, conflicts of interest and, potentially, compensation practices as well. The recent trading losses in Europe illustrate the case for restrictions on proprietary trading and limiting participation in sponsoring private pools of capital beyond US institutions.

Commenting on the recent UK Vickers Report, Mr. Volcker said that, while there are differences in the structural approaches in the U.S. and U.K., the two jurisdictions are in fundamental agreement on the key importance of protecting traditional commercial banking from the risks and conflicts of proprietary activity.

Chairman Volcker also recommended that regulators take steps to increase competition among credit rating agencies, and emphasize investor reliance on in-house credit analysis. He also urged the Administration and Congress to commit to an orderly wind down of Fannie and Freddie, replacing the government’s role in residential mortgages with that of private financial institutions.

It is important to address the role of money market mutual funds in the United States, said the Chairman, adding that the time has come to harness money market funds in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential.

By grace of an accounting convention, he noted, money market fund shareholders are permitted to meet requests for withdrawals upon demand at a fixed dollar price so long as the market valuation of fund assets remains within a specified limit around the one dollar par, in the vernacular “the buck.” Started decades ago essentially as regulatory arbitrage, said the former Fed Chair, money market funds today have trillions of dollars heavily invested in short-term commercial paper, bank deposits, and notably recently, European banks.

Free of capital constraints, official reserve requirements, and deposit insurance charges, money market funds are hidden in the shadows of banking markets, said Mr. Volcker, resulting in diverting what amounts to demand deposits from the regulated banking system. While generally conservatively managed, the funds are vulnerable in troubled times to disturbing runs, highlighted in the wake of the Lehman bankruptcy.

If money market funds wish to continue to provide on so large a scale a service that mimics commercial bank demand deposits, said the Chairman, then strong capital requirements, official insurance protection, and stronger official surveillance of investment practices is called for. Simpler and more appropriately, they should be treated as an ordinary mutual fund, with redemption value reflecting day by day market price fluctuations.

In Mr. Volcker’s view, the greatest structural challenge facing the financial system is how to deal with the wide-spread impression that important financial institutions are too large or too interconnected to fail. The expectation that taxpayers will help absorb potential losses can only reassure creditors that risks will be minimized and help induce risk-taking on the assumption that losses will be socialized, with the potential gains all private. Understandably, noted the Chairman, ``the body politic feels aggrieved and wants serious reforms.’’

First, he said, the risk of failure of large, interconnected firms must be reduced, whether by reducing their size, curtailing their interconnections, or limiting their activities. Second, ways and means must be found to manage a prompt and orderly financial resolution process for firms that fail or are on the brink of failure, minimizing the potential impact on markets and the economy without massive official support. Third, key elements in the approach toward failures need to be broadly consistent among the major financial centers in which the failing institutions have critical operations.

In passing the Dodd-Frank Act, he continued, the United States has taken an important step in the needed directions. But a truly convincing approach to deal with the moral hazard posed by official rescue is critically dependent on complementary action by other countries.

With regard to resolution authorities, said the Chairman, success will depend on complementary approaches taken in major financial centers. Essentially, the authorities need to be able to cut through existing and typically laborious national bankruptcy procedures. The need is for new resolution authorities that can maintain necessary services and day-to-day financing while failing organizations are liquidated, merged or sold, whether in their entirety or piece by piece.

Such resolution arrangements are incorporated in Dodd-Frank, observed Mr. Volcker, but there is skepticism as to whether they will be effective in the midst of crises, and whether market participants will continue to presume that governments will again “ride to the rescue”. In his view, that skepticism is likely to remain until the most important of jurisdictions can be brought into reasonable alignment. His sense is that efforts are well underway to clear away some of the technical underbrush and agree on procedures for intervention and exchanging information. An important element in that effort is the concept of requiring institutions to develop “living wills”. The idea here is to have clarity as to parts of their operations that could stand alone or be sold or merged as part of an orderly and rapid resolution process

Finally, the Chairman noted that the UK Independent Commission on Banking, the Vickers Commission, recently proposed a more sweeping structural change for organizations engaged in commercial banking. In essence, within a single organization the range of ordinary banking operations, such as deposit taking, lending, and payments, would be segregated in a retail bank, which would be overseen by its own independent board of directors and ring fenced to greatly reduce relations with the rest of the organization.

Apparently, said Mr. Volcker, the Vickers Report envisions that customers could deal with both parts of the organization, and some limited transactions permitted between them. But as he understands it, the retail bank would be much more closely regulated, with relatively high capital and other stringent requirements. The emphasis is to insulate the bank from failures of the holding company and other affiliates. There seems to be at least a hint that public support may be available in time of crisis, he said, which presumably would be ruled out for other affiliates of the financial institution.

While acknowledging that he has not absorbed all the practical and legal implications of the U.K. proposal, Mr. Volcker said that ``surely problems abound’’ in trying to separate the fortunes of different parts of a single organization. Directors and management of a holding company are assumed to have responsibility to the stockholders for the capital, profits and stability of the whole organization, he reasoned, which does not fit easily with the concept that one subsidiary, namely the retail bank, must have a truly independent board of its own. As an operational matter, some interaction between the retail and investment banks is contemplated in the interest of minimizing costs and facilitating full customer service. The US experiences with fire walls and prohibitions on transactions between a bank and its affiliates have not been entirely reassuring in practice, said the former Fed Chair.

G-20 Finance Ministers and Central Bankers Support Globally Consistent Derivatives Regulation and Int'l Accounting Standards

The G-20 Finance Ministers and Central Bankers have reaffirmed their commitment to implement the regulation of OTC derivatives in a globally consistently and nondiscriminatory manner. This dovetails with the statement by the G-20 Leaders at last year’s Seoul Summit affirming the regulation of the OTC derivatives market reforms is an internationally consistent manner. In the communiqué ending their October 2011 meeting, the finance ministers and central bankers also emphasized their full commitment to achieve a single set of high quality global accounting standards, again aligning with the Leaders’ earlier endorsement of one set of global accounting standards. The Leaders also encouraged the International Accounting Standards Board to further improve the involvement of stakeholders, including the membership of emerging market economies, in the process of setting the global standards, within the framework of the independent accounting standard setting process.

The finance ministers and central bankers also endorsed a comprehensive framework to reduce the risks posed by systemically important financial institutions. This frame work should consist of strengthened regulation, effective resolution regimes, and a vehicle for cross‐border cooperation. They also agreed on initial recommendations and a work plan to strengthen regulation and oversight of shadow banking. The group also debated options for innovative financing, as well as a range of different financial taxes.

At the Seoul Summit last year, the G-20 Leaders reaffirmed that no financial firm should be too big or too complicated to fail and that taxpayers should not bear the costs of resolution. They endorsed the policy framework proposed by the Financial Stability Board to reduce the moral hazard risks posed by systemically important financial institutions and address the too-big-to-fail problem. This requires a multi-pronged framework combining: a resolution framework and other measures to ensure that all financial institutions can be resolved safely, quickly and without destabilizing the financial system and exposing taxpayers to the risk of loss.

The framework also envisions that financial institutions that are globally systemic should have higher loss absorbency capacity to reflect the greater risk that the failure of these firms poses to the global financial system. In the context of loss absorbency, the G-20 Leaders encourage further progress on the feasibility of contingent capital.

Saturday, October 22, 2011

In Supreme Court Amicus Brief: Securities Industry and Chamber Contend that Section 16(b) Limitations Period Is a Period of Repose

The limitations period in Section 16(b) of the Exchange Act is a period of repose and runs from the time of the violation when profit was realized, said a US Supreme Court amicus brief filed by SIFMA and the Chamber of Commerce. When Congress wanted a limitations period to run from the discovery of a violation in the Exchange Act it know how to expressly say so, noted the brief, and in Section 16(b) it did not say so. Thus, amicus contends that a Ninth Circuit panel erred in ignoring that the plain statutory language establishes a period of repose. The panel held that the two-year limitations period in Section 16(b) is tolled until the insider discloses his or her transactions in a Section 16(a) filing, regardless of whether the plaintiff knew or should have known of the conduct at issue. The US Supreme Court has set November 29, 2011 for the date of oral argument. Credit Suisse Securities v. Simmonds, Dkt. No. 10-1261.

The Ninth Circuit’s misreading of the statute is particularly problematic, continued the brief, because virtually all of the litigation under Section 16(b) is driven by attorneys’ fees, not by harm to any plaintiff. Because any profits recovered in the litigation (minus attorneys’ fees) go to the corporation itself, the named plaintiffs have almost no personal stake in the litigation. In these circumstances, reasoned amicus, any form of tolling is particularly unwarranted. Moreover, in linking the limitations period of Section 16(b)
to compliance with Section 16(a), the Ninth Circuit has allowed Section 16(b)’s limitations period to be extended indefinitely, regardless of when the profit was realized or when a plaintiff should have known of the profit.

In the view of SIFMA and the Chamber, the Ninth Circuit adopted a tolling rule for the express limitations period in Section 16(b) that is inconsistent with the text and purpose of Section 16 and the Exchange Act as a whole. By its terms, the statute reflects that the two-year limitations period is an absolute outside limit on bringing suit, noted the brief, a conclusion confirmed by the legislative backdrop.

Section 16(b) provides for the recovery from company insiders of short-swing profits and also states that no suit for such recovery can be brought more than two years after the date such profit was realized. Congress could have adopted a different scheme, noted amicus. For example, it could have made the limitations period commence on the date that the transaction was reported under the disclosure requirements of Section 16(a) or Congress could have made the date run from when the company knew of or should have discovered the realized profit. But Congress did not. Instead, Congress clarfied that the limitations period runs from the time the violation was completed, i.e., “after the date such profit was realized.”

According to the brief, ting a limitations period to a wrongful act (as opposed to the plaintiff ’s injury) is typical when Congress intends the period to be one of repose, not subject to tolling. Moreover, Congress created the cause of action and the limitations period in the same sentence, noted amicus, suggesting that Congress intended to treat the limitations period as an integral part of the cause of action itself, and not simply a limit on the remedy. That close textual link also shows that Congress did not intend the limitations period to be subject to tolling.