Thursday, May 31, 2012

House Panel Approves Legislation Adjusting Date of Asset Test for Banks Counting Trust Preferred Securities as Tier 1 Capital

The House Financial Services Committee approved legislation, HR 3128, amending Section 171 of the Dodd-Frank to adjust the date in which consolidated assets are determined for the purpose of exempting trust preferred securities of smaller financial institutions from Tier 1 capital deductions. The vote was 35-15. Section 171, inserted into Dodd-Frank through an amendment offered by Senator Susan Collins (R-ME), enhances bank capital and ensures that banks have adequate capital cushions.

Section 171 eliminated Tier 1 capital treatment for trust preferred securities for all financial institutions with $15 billion or more in assets. However, financial institutions with less than $15 billion in assets (as of December 31, 2009) were allowed to continue counting trust preferred securities as Tier 1 capital. Trust preferred securities are part equity and part debt and are usually issued by a bank holding company through a special purpose entity

HR 3128 would adjust the date that regulators must use for determining if a bank holding company falls under the exemption in the Collins Amendment which allows them to use trust preferred securities from December 31, 2009 to March 31, 2010. In order to be granted the exemption, the financial institution must have assets under $15 billion on the statutory date. According to Rep. Michael Grimm (R-NY), the sponsor of the legislation, this change will ensure that smaller financial institutions are not needlessly robbed of capital, which would have a direct impact on their lending capacity. Rep. Carolyn Maloney (D-NY), in supporting HR 3128, noted that it does not change any of the substance of the Collins Amendment.

Chairman Spencer Bachus (R-AL) said that HR 3128 is designed to correct an unintended consequence of the Dodd-Frank Act. In supporting HR 3128, Ranking Member Barney Frank (D-MA) said that the FDIC has no position on the bill, nor does any other financial regulator.  Rep. Frank assured that the bill provides a temporary fix, and does work a permanent reduction in capital requirements.


Representatives Maloney and Grimm noted that HR 3128 is designed to ensure that the Collins Amendment does not punish smaller banks that historically had assets under $15 billion but, in an act of prudence, for a brief period during the financial crisis took on extra assets to enhance stability and went over $15 billion. HR 3128 is a minor adjustment of the date for looking at the assets of a financial institution. Rep. Gregory Meeks (D-NY) noted that the retroactive date of the Collins Amendment had an unintended significant consequence on smaller financial institution, and HR 3128 corrects that.

NASAA Suggests Improvements to Expungement Process


NASAA recently offered suggestions to the Financial Industry Regulatory Authority (FINRA) on ways to improve the expungement process by providing a clear procedure for unnamed persons to seek expungements of customer dispute information from the Central Registration Depository (CRD). In a comment letter in response to FINRA Regulatory Notice 12-18, NASAA wrote that it is important to ensure that customers in underlying arbitration cases have notice of expungement requests and the opportunity to object. FINRA had requested comments on proposed new rules that would permit persons who are the “subject of" allegations of sales practice violations made in arbitration claims, but who are not named as parties to the arbitration, to seek expungement relief by initiating "In re" proceedings at the conclusion of the arbitration.

NASAA encouraged FINRA to codify a procedure for mandatory customer notification of an unnamed person’s request for expungement. NASAA suggested that FINRA should send a notice to the complainant once the unnamed person has filed the submission agreement. The notice should explain that the unnamed person is seeking to expunge the reportable event and provide the customer-complainant with sufficient information to appear and object if the complainant wishes to do so. Complainants should have at least 30 days to object to the expungement request, and no presumptions should be made or conclusions drawn based on a customer’s absence from a hearing.

Additionally, NASAA believes that the issue of whether or not a customer complaint should be deleted from an associated person’s CRD record is of such importance that it should be fully considered by a panel of arbitrators who are familiar with the underlying case. Furthermore, NASAA believes that whether a person seeking expungement was a named party or remained unnamed should not determine the number of arbitrators making the decision to expunge a person’s record. In NASAA’s view, the proceeding should be considered a part of the arbitration process, even if procedurally it occurs after the customer’s case in chief has been concluded. Accordingly, the standard option for In re proceedings should be a hearing by the entire panel that heard the underlying case.

NASAA observed that, under proposed Rule 13807(h), FINRA would appoint a single public arbitrator who was the public chairperson of the panel, if willing and available. NASAA believes, however, that it is in the public interest and the interest of the unnamed party that the arbitrators most familiar with the intricacies of the dispute be charged with deciding the appropriateness of expungement. If the full panel is unavailable to hear the case, NASAA suggested that the next option would be for the other remaining panel members to be appointed to hear the In re expungement proceeding. Although understanding that the entire panel may always not be willing or available to serve in the In re expungement proceeding, NASAA believes that such instances should be minimal if FINRA makes it clear to the panel at the onset of the arbitration that it may be called on to address an expungement request after the customer’s case in chief has been concluded.

If FINRA requires the original panel to hear the In re expungement, NASAA recommended that FINRA Rule 12213, which requires consideration of the customer’s location when choosing a hearing location, also apply to In re proceedings. If, however, FINRA does not require the original panel to determine the In re hearing outcome, NASAA urged that additional procedures be put into place to consider the customer’s location when choosing the hearing location and that these procedures reflect FINRA Rule 12213.

NASAA wrote that it is important that FINRA clarify that all provisions of Rule 2080, which contains the standards and procedures for expungement of customer dispute information from the CRD, will apply to the new In re expungement proceedings. NASAA believes that these provisions provide safeguard procedures that serve to uphold the integrity of the CRD system and strengthen investor protection by providing an accurate record of an associated person’s customer dispute history.

Finally, NASAA urged FINRA to use this opportunity to take two additional steps to further improve the expungement process. First, NASAA urged FINRA to provide additional guidance to arbitrators by clarifying that a decision to deny relief to customers is not a sufficient reason to grant an expungement request. As one of the grounds for granting expungement is a finding that the claim is “false," NASAA suggested that arbitrators should be reminded that a decision in favor of the associated person does not equate to a finding that the claim is false. Second, NASAA suggested that FINRA codify a process whereby state regulators who may want to object to expungement are provided notice, even when FINRA intends to grant a waiver request. NASAA stated that FINRA and the states have differing statutory requirements for registration and licensing of associated persons and disclosure of arbitration proceedings in public records. Therefore, NASAA urges that states be notified regarding court confirmation proceedings involving expungements, even when FINRA waives its role as a party.




NFA Proposes New Seg Funds Requirement, AKA ``Corzine Rule''


The National Futures Association (NFA), the self-regulatory organization for the U.S. futures industry, has proposed several measures to tighten control over customer segregated funds held by commodity futures brokers, known as futures commission merchants (FCMs). Most significantly, the rule would require written approval by the CEO or CFO of withdrawals of more than 25% of the FCM's “residual interest” in customer segregated funds.
The proposed measure is popularly referred to as the “Corzine Rule” after the former CEO of MF Global, a major FCM that suddenly went bankrupt last fall.  In the days leading up to the firm’s failure, funds were transferred from customer segregated funds to cover the firm’s proprietary trades. Jon Corzine has stated that he was not aware of the fund transfers.

Under CFTC Rule §1.23, FCMs are permitted to retain a residual financial interest in customer funds in excess of the amount necessary to meet segregation requirements, as long as the residual interest is properly segregated and accounted for.  Also known as “excess funds”, these funds may be used to make up any deficiency in a customer’s account if the customer fails to have sufficient funds on deposit with the FCM to meet the customer’s obligations.

The proposed measure would require that if a transfer is made exceeding 25% of the FCM’s residual interest in a customer segregated fund account, the firm's CEO, CFO or other defined principal must pre-approve the transaction in writing. The FCM must also  immediately file a written notice with NFA providing details of the transaction, including the reason for the disbursement and the current estimate of the remaining total residual interest in the accounts, along with a representation that the FCM remains in compliance with the segregation requirements.

In addition to the approval and notification requirement, FCMs will be required to have written policies and procedures regarding the maintenance of the firm's residual interest in its customer segregated funds. The policies and procedures must target an amount, either by percentage or dollars, that the FCM seeks to maintain as its residual interest in those accounts, and ensure that the FCM remains in compliance with the applicable segregation requirements.

Futher, FCMs will be required to provide NFA with certain financial and operational information on a monthly or semi-monthly basis. NFA will subsequently make some of the information publicly available on its website in the future.

"These new requirements will help begin the process of restoring public confidence in the financial integrity of customer segregated funds," said Roth. "Making this information available to the public will give investors a better picture of the financial standing of the FCM with which they are conducting business."

The proposed new requirements were approved by NFA's Board of Directors on May 17. NFA has submitted the proposed financial requirements and accompanying interpretive notice to the CFTC for approval.


This post was contributed by my colleague Lene Powell. 

SEC Staff Advise Foreign Private Issuers on Confluence of Non-Public Submission Policy and JOBS Act Emerging Growth Companies


The Division of Corporation Finance has reminded that foreign private issuers submitting draft registration statements pursuant to the foreign issuer non-public submission policy or as an emerging growth company under the JOBS Act are required, at the time they publicly file their registration statements, to also publicly file their previously submitted draft registration statements and resubmit all previously submitted response letters to staff comments as correspondence on EDGAR. All staff comment letters and issuer response letters will be posted on EDGAR in accordance with staff policy. For foreign private issuers making non-public submissions pursuant to this policy, and not pursuant to the procedures available to emerging growth companies, this requirement will only apply to registration statements where the initial draft submission is made after May 30, 2012.

Recognizing that foreign private issuers face unique circumstances when accessing U.S. public markets in connection with the initial registration of their securities, the Division has afforded foreign private issuers the ability to submit to the staff registration statements and amendments on a non-public basis in connection with their first-time registration, permitting the staff to review and comment on disclosure, and the issuer to respond to staff comments, before a public filing is made through the EDGAR system.

In December 2011, the Division limited its policy with respect to the non-public submission of initial registration statements by foreign issuers. Since then, the staff reviews initial registration statements of foreign issuers that are submitted on a non-public basis only where the registrant is: (1) a foreign government registering its debt securities; (2) a foreign private issuer that is listed or is concurrently listing its securities on a non-U.S. securities exchange; (3) a foreign private issuer that is being privatized by a foreign government; or (4) a foreign private issuer that can demonstrate that the public filing of an initial registration statement would conflict with the law of an applicable foreign jurisdiction.

This non-public submission policy is separate from the confidential registration statement review procedures available to emerging growth companies under the Jumpstart Our Business Startups Act. Foreign private issuers that meet the requirements in the JOBS Act are eligible to be treated as emerging growth companies.

Foreign issuers that are eligible under the non-public submissions policy must submit their draft registration statements in the same manner as emerging growth companies under the JOBS Act. Foreign private issuers who seek to qualify as emerging growth companies under the JOBS Act should consult the Division’s information relating to Title I of the JOBS Act.

The staff noted that foreign private issuers seeking to be treated as emerging growth companies must, among other things, follow the procedures applicable to emerging growth companies with respect to both confidential submissions and the timing of the public filing of their registration statements.



Wednesday, May 30, 2012

NY Court of Appeals Refuses to Carve Out Exception from Employee-At-Will Doctrine for Hedge Fund Compliance Officer


The New York Court of Appeals refused to carve out an exception for a hedge fund’s chief compliance officer from the common law doctrine that does not recognize a cause of action for the wrongful discharge of an employee-at-will. While acknowledging that compliance with extensive SEC regulations overseen at hedge funds by compliance officers is an integral part of the securities business, the court said that the existence of federal regulation furnishes no reason to make state common law governing the employer-employee relationship more intrusive. In an opinion by Judge Smith, the court said that Congress can regulate that relationship itself to the extent that it thinks the objectives of federal law require it. The court rejected that the assertion that the legal and ethical duties of a securities firm and its compliance officer justify recognizing a cause of action for damages when the compliance officer is fired for objecting to misconduct, such as deceptive trading practices. Sullivan v. Harnisch, New York Court of Appeals, No. 82, May 8, 2012.

The chief compliance officer emphasized the importance of compliance officers in the overall scheme of federal securities regulation to which the hedge fund, as a registered investment adviser, was subject. The SEC has found that it is critically important for funds and advisers to have strong systems of controls in place, and requires each registered adviser to designate a chief compliance officer who will be responsible for administering policies and procedures designed to prevent violations of federal law and regulations. From this, the chief compliance officer analogized that compliance with securities laws was central to his relationship with the hedge fund in the same way that ethical behavior as a lawyer was central to employment at a law firm.

Important as regulatory compliance is, said the court in rejecting the analogy, the regulatory and ethical obligations of the chief compliance officer and his duties as an employee were not so closely linked as to be incapable of separation. The chief compliance officer was not associated with other compliance officers in a firm where all were subject to self-regulation as members of a common profession. Indeed, he was not even a full-time compliance officer. He had four other titles at the hedge fund, including executive vice president and chief operating officer, and was, according to his claim, a 15 percent partner in the business. Thus, the court found that regulatory compliance was not at the core and the only purpose of his employment.

Congress passed the Dodd-Frank Act, which in Section 922 provides whistleblower protection, including a private right of action for double back pay, for employees who are fired for furnishing information about violations of the securities laws to the SEC (Dodd-Frank Act § 922 [a], 15 USC § 78u-6). But Section 922 seems not to apply to conduct like that alleged here, said the Court, since the chief compliance officer does not claim to have blown a whistle, that is, he does not claim to have told the SEC or anyone else outside the hedge fund about the alleged misconduct. Nothing in federal law persuaded the court to change New York law to create a remedy where Congress did not.


Financial Industry Applauds US Supreme Court Ruling Protecting Credit Bidding for Secured Lenders under Bankruptcy Code


In an outcome desired by the hedge fund and securities industries, the US Supreme Court ruled that a Chapter 11 bankruptcy plan may not be confirmed over the objection of a secured creditor bank if the plan provides for the sale of collateral free and clear of the creditor’s lien but does not allow  the creditor to credit-bid at the sale. The Court said that the ability to credit-bid protects a creditor against the risk that its collateral will be sold at a depressed price and enables the creditor to purchase the collateral for what it considers the fair market price without committing additional cash to protect the loan.  RadLAX Gateway Hotel, LLC v. Amalgamated Bank, Dkt. No. 11-166.

The hedge fund, securities and banking industries, along with other financial trade associations, earlier filed an amicus brief in the US Supreme Court arguing that the federal bankruptcy code does not allow a debtor to bar secured lenders from credit bidding to protect themselves against the potential undervaluation of their collateral in bankruptcy. A new rule allowing debtors to bar credit-bidding would increase the risk of undervaluation, they argued, and to compensate for that risk lenders would be forced to increase the cost of capital, contended the Managed Funds Association, SIFMA, and the American Bankers Association, among others.

They said that such a rule would have a significant negative impact on the market for secured financing at a moment when the ready availability of affordable credit remains essential to the national economic recovery. Generally supporting the trade groups, the US government also filed an amicus brief stating that a creditor’s opportunity to bid cash at an asset sale is not an adequate substitute for the right to bid credit.

Second Circuit Allows S-K Item 303 Claim Against Chip Maker to Proceed

In a second look at a case arising from allegedly undisclosed defects in semiconductor chips, the 2nd Circuit allowed claims of Securities Act 11, 12(a)(2) and 15 violations to move forward. The court found that the allegations stated a claim for failure to comply with the disclosure requirements of Regulation S-K Item 303. Under this provision, registrants must discuss in the MD&A section “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.”

The issuer, Ikanos Communications Inc., manufactured programmable semiconductors for sale to equipment manufacturers for telecommunications carriers. Ikanos learned in January 2006 that there were quality issues with some of its chips that caused the networks operated by end users to fail. The company conducted a secondary stock offering in March 2006. The registration statement and prospectus did not specifically disclose the defect issue. Rather, the documents stated in general terms that its “highly complex products…frequently contain defects and bugs.” Ikanos eventually had to pay to replace at its expense all of the units sold to two of its largest customers.

The appellate court emphasized that when “viewed in the context of Item 303's disclosure obligations, the defect rate, in a vacuum, is not what is at issue. Rather, it is the manner in which uncertainty surrounding that defect rate, generated by an increasing flow of highly negative information from key customers, might reasonably be expected to have a material impact on future revenues.” Two allegations in the complaint were crucial to the court’s decision. The first was that Ikanos was receiving regular and increasing numbers of complaints from two customers that represented more than 70 percent of the company’s revenues. The second was that Ikanos knew when it was receiving the complaints that it would be unable to determine which chip sets contained defective chips, and that all of the chip sets sold to these major customers would have to be replaced.

The court concluded that the “reasonable and plausible inferences from these allegations are not simply that Ikanos quite possibly would have to replace and write off a large volume of chip sets, but also that it had jeopardized its relationship with clients who at that time accounted for the vast majority of its revenues.” The court stated that “Item 303’s disclosure obligations, like materiality under the federal securities laws’ anti-fraud provisions, do not turn on restrictive mechanical or quantitative inquiries." In light of the allegations concerning known defects in sales to major customers, the court found that the generic discussion of bugs and defects was inadequate.

Panther Partners Inc. v. Ikanos Communications Inc.

.

Fed Adopts Final Rule for Registration of Securities Holding Companies


The Federal Reserve Board has adopted a final rule to implement the registration requirements for securities holding companies under Dodd-Frank Act Section 618. This provision allows a securities holding company that is required by a foreign regulator or foreign law to be subject to comprehensive consolidated supervision to register with the Fed as a supervised securities holding company. The economic analysis accompanying the rule indicates that five entities may avail themselves of the rule.

The new rule defines “securities holding company” to mean any company that owns or controls, is controlled by, or is under common control with, one or more brokers or dealers registered with the Securities and Exchange Commission and is required by a foreign regulator or provision of foreign law to be subject to comprehensive consolidated supervision. The term excludes certain nonbank financial companies, insured banks or savings associations and their affiliates, foreign banks, and companies currently subject to comprehensive consolidated supervision by a foreign regulator. Supervised securities holding companies must comply with the Bank Holding Company Act of 1956, except for the provisions contained in Section 4 dealing with restrictions on nonbanking activities.

Securities holding companies that elect to register with the Fed will need to complete a new form being developed by the Fed. A securities holding company must file the form with the responsible reserve bank, as determined by the Director of Banking Supervision and Regulation at the Fed. The Fed may request additional necessary information. A registration is deemed filed on the date that all required information on the form is received. A registration generally is effective 45 calendar days after the date on which the responsible reserve bank received the complete filing. The Fed, however, may give written notice to a securities holding company that its registration is effective before 45 calendar days.

Kentucky Adds Inspection Fees for IAs with AUM Exceeding $20 Million and for Firms Employing Issuer-Agents

Fees for the Kentucky Department of Financial Institutions' staff to examine investment advisers with assets under management above $20 million were adopted to cover the higher threshold advisers that will be subject to state rather than federal regulation in light of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Investment advisers (IAs) with assets under management (AUM) of between $20 and $30 million pay $350; IAs with AUM of between $30 and $45 million pay $450; IAs with AUM of between $45 and $60 million pay $550; IAs with AUM of between $60 and $75 million pay $650; and IAs with AUM exceeding $75 million pay $750. The fee for examining broker-dealers and firms employing issuer-agents is $35 per working hour up to a total maximum fee of $1,000. NOTE: A fee is not charged for training hours on an examination.

House Members Urge SEC, CFTC and Banking Agencies Not to Delay Volcker Regulations


In a letter to the SEC, CFTC and the banking agencies implementing the Volcker Rule provisions of the Dodd-Frank Act, 35 House Members said that the Volcker regulations must be finalized this summer. While the proposed regulations are not perfect, acknowledged the Members, they should not be delayed or scrapped.

Rather, the Members, many of whom sponsored and co-sponsored the Volcker provisions, urged the SEC, CFTC and banking agencies to adopt the best elements from the proposal, eliminate unnecessary loopholes, draw clear lines based on objective data and observable markets, strengthen CEO and board-level accountability and public disclosure, and provide coordinated and consistent enforcement, including data sharing by regulators. They also urged the regulators to maintain and ensure ease of compliance for the overwhelming number of community and regional banks that do not engage in covered activities.


The Volcker Rule provisions of the Dodd-Frank Act (Section 619) prohibit financial institutions from engaging in proprietary trading and sponsoring and maintaining hedge funds, while permitting market making and the hedging of risk. While the vast majority of banks will be unaffected by the provisions, observed the Members, the prohibition on proprietary trading will unquestionably reduce some banks' trading. Proprietary trading, regardless of where it occurs within a bank, is prohibited by Section 619. The Members noted that the banks directly impacted by the Volcker Rule have already had nearly two years to realign their businesses to comply with the broad contours of the rule, and many have already taken steps to do so. The Dodd-Frank Act provides for an additional two years, extendable up to five years, for financial firms to come into compliance with the Volcker Rule. The House Members suggested that during this period additional guidance may be offered as new data becomes available or with respect to particular provisions that may require deeper analysis, for example, prohibited conflicts of interest or high-risk trading strategies.

SEC Staff Begins to Issue JOBS Act Comment Letters on EGC Status


The SEC staff has begun to issue comment letters to issuers who may claim emerging growth company (EGC) status.  The EGC is a new type of entity created by the Jumpstart Our Business Startups (JOBS) Act, which became law April 5, 2012. JOBS Act Title I contains scaled disclosure obligations for EGCs.

In comments to Ares Commercial Real Estate Corporation and Fiesta Restaurant Group, the staff noted that each firm appeared to qualify for EGC status. As a result, the staff requested that these companies note their EGC status on their prospectus or information statement cover pages and provide the following disclosures:

·        How and when the company may lose EGC status;

·        A brief description of available JOBS Act exemptions (including the exemption from the internal controls auditor attestation requirement under Sarbanes-Oxley Act Section 404(b) and the exemption from certain executive compensation requirements under Exchange Act Section 14A(a) and (b)); and

·        With respect to the JOBS Act Section 107(b) election: (1) a statement that the firm’s election to opt out of the extended transition period to comply with new or revised accounting standards is irrevocable, or (2) upon electing to use the extended transition period to comply with new or revised accounting standards, include a risk factor stating this election permits the company to delay adoption of certain accounting standards with different effective dates for public and private companies until the standards apply to private companies; The risk factor also must state that due to the election, the firm’s financial statements may not be comparable to those of firms that comply with public company effective dates; Similar disclosure must be made in the company’s MD&A critical accounting policies section.

The SEC staff, in comments to Proofpoint, Inc., observed that the company’s JOBS Act disclosures may inadequately describe when the firm must provide an annual assessment and auditor attestation on internal controls over financial reporting. Specifically, the company must clarify whether it is an EGC and disclose that EGC status excuses the company from the requirements of Sarbanes-Oxley Act Section 404(b) for up to five years. Proofpoint must further disclose the circumstances that may end its EGC status and thus require compliance with Sarbanes-Oxley Act Section 404(b). The staff also asked the firm to consider whether disclosure to investors of the modified disclosure and reporting requirements for EGCs is necessary or appropriate. In particular, the company should consider the effect of EGC status on its investors and the firm’s access to capital.

At the time of publication, the companys' replies to these staff comments were not publicly available on EDGAR. Additionally, the SEC staff has issued numerous documents providing guidance to EGCs under the JOBS Act.

SEC Approves FINRA Fee Schedule for Filing of Form PF by Hedge Fund and Private Fund Advisers


The SEC has approved FINRA filing fees for SEC-registered hedge fund advisers and other private fund advisers filing Form PF. Release No. IA-3305. Filing fees are charged for annual reports ($150) and quarterly reports ($150) to Form PF. Hedge fund and private fund advisers will file Form PF online through the Private Fund Reporting Depository (PRFD) System, which is a subsystem of the IARD system. No fee will be charged for filing an electronic amendment to Form PF, or for a transition to annual reporting filing.

Form PF is a two-tier scaled regime with enhanced reporting for larger funds based on an assets under management test. While Form PF is primarily intended to assist the Financial Stability Oversight Council in its monitoring obligations under the Dodd-Frank Act, the SEC may use information collected on Form PF in its regulatory programs, including examinations, investigations and investor protection efforts relating to private fund advisers.

Registered advisers managing hedge funds must submit information on Form PF regarding the financing and activities of these funds in Section 1 of the Form, and large hedge fund advisers are required to provide additional information in Section 2 of the Form.

Most private fund advisers required to file Form PF will only need to complete Section 1 of the Form. This section requires advisers to provide some basic information regarding any private funds they advise in addition to information about their private fund assets under management and their funds’ performance and use of leverage. However, larger private fund advisers must complete additional sections of Form PF, which require more detailed information.

Specifically, three types of large private fund advisers would be required to complete additional sections of Form PF. First, any adviser having at least $1.5 billion in regulatory assets under management attributable to hedge funds as of the end of any month in the prior fiscal quarter must complete Section 2 of Form PF. Second, any adviser managing a liquidity fund and having at least $1 billion in combined regulatory assets under management attributable to liquidity funds and registered money market funds as of the end of any month in the prior fiscal quarter must complete Section 3 of Form PF.  Third, any adviser having at least $2 billion in regulatory assets under management attributable to private equity funds as of the last day of the adviser’s most recently completed fiscal year must  complete Section  4 of Form PF.

The information each of these sections requires is tailored to the type of fund, focusing on relevant areas of financial activity that have the potential to raise systemic concerns.

Washington Adopts Mortgage Paper Securities Rule Amendments

Rules providing an optional method for registering mortgage paper securities were amended by the Washington Department of Financial Institutions, effective June 17, 2012. The rules strengthen investor suitability requirements, revise the calculation of the number of investors that may participate in a loan, establish requirements for participation agreements, revise net worth and bonding requirements, revise provisions regarding escrow accounts and escrow agreements, establish requirements for servicing agreements, codify the requirement for a disclaimer in advertisements, clarify the fiduciary duties of a mortgage broker-dealer, include additional dishonest and unethical practices, clarify the requirements for appraisals, clarify investors' rights to receive information and access records concerning their investments, and update recordkeeping requirements.

Tuesday, May 29, 2012

House Leaders Urge SEC to Adopt Regulations Requiring Disclosure of Corporate Spending in Elections


In a letter to the SEC, Rep. Michael Capuano (D-MA) asked the Commission to adopt regulations requiring disclosure of corporate spending in elections. Similarly, he urged the SEC to require a vote from company shareholders before that corporation may use its general treasury funds for political spending. The House Member noted that the Supreme Court’s 2010 decision in Citizens United v. Federal Election Commission changed the face of campaign finance for elections by authorizing, for the first time, unlimited  political spending by corporations, which the Supreme Court understands to fall under the definition of person. Rep. Capuano is the Ranking Member on the House Oversight and Investigations Subcommittee.

While the FEC undoubtedly has jurisdiction over election matters, he noted, the SEC has the authority to  promulgate rules regarding the  procedures through which companies spend  their treasury funds, which, after all, is shareholders' money, for political purposes,  as well  as disclosure of  that spending as material information to shareholders.  Since the Citizens United decision, said Rep. Capuano, shareholders have shown a marked interest in participating in  political spending decisions and have submitted numerous proposals to include robust political spending disclosures in proxy statements.

Rep. Capuano has introduced legislation requiring the SEC to implement through regulation a shareholder vote authorizing corporate political spending. Under the process set up in H.R. 2517, the Shareholder Protection Act, shareholders would vote annually to authorize a political spending budget, at an amount set by the corporation, by majority vote.  The corporation would then disclose to shareholders and the SEC, via existing reports and on the Internet, the amounts spent and for what purposes.  While the Shareholder Protection Act could serve as a model for the SEC, Representative Capuano is open to other approaches that would accomplish the same goals.

He emphasized that shareholders have the right to decide if their money is spent for political purposes and to be notified of its specific use. Since the SEC clearly has the authority to enforce such accountability and disclosure, he urged the Commission to act to protect shareholders by requiring a shareholder "say" on political spending and ensuring proper disclosure.

In a letter to the Commission last October, a consortium of over 40 House Members, including Rep. Carolyn Maloney (D-NY), urged the SEC to use its authority to issue rules requiring full public release of corporate political spending. Describing the present system as undemocratic and untenable, the Members said that the Citizens United ruling has left shareholders completely in the dark, unaware that their money could be funding political attack ads. In order to protect the rights of shareholders, said the Members, the SEC should adopt regulations requiring corporations to disclose their political spending to shareholders. Shareholders cannot hold corporate management accountable for decisions the shareholders never knew were made, reasoned the Members. Rep. Maloney is the Ranking Member on the House Financial Institutions Subcommittee.


Requiring disclosures of corporate political spending does not have to be overly burdensome on business, explained the Members, since the SEC can use existing mediums of shareholder communication to facilitate disclosure, including proxy statements, quarterly and annual reports, and registration statements.  Further, in order to ensure that shareholders are informed of all political spending, the disclosures should include spending on independent expenditures, electioneering communications, and donations to outside groups for political purposes, such as super-PACs.

Pending EU Legislation Would Require Mandatory Rotation of Credit Rating Agencies


Pending EU legislation amending the regulation of credit rating agencies would introduce  several provisions on mandatory rotation for rating analysts and credit rating agencies with the aim of achieving greater competition in that sector, said Stephen Maijoor, Chair of the European Securities and Markets Authority. In recent remarks, he noted that the regulatory framework for rating agencies will probably be soon amended by the CRA 3 Regulation, which is currently being negotiated at the European Parliament and at the Council. Since July 1, 2011 ESMA has been the exclusive regulator of credit rating agencies in the EU.

The CRA 3 legislation also includes a proposal for a new disclosure platform to be run by ESMA to improve the level of transparency of the credit rating market. As regards the prevention of conflicts of interest, the proposed legislation states that rating agencies must not issue credit ratings when their major shareholders have interests in the rated entity, or when the rated entities are major rating agency shareholders themselves. The legislation also provides that EU Member States must ensure civil liability for the infringements of the CRA Regulation made with intent or through gross negligence.

With regard to current CRA Regulation, Chairman Maijoor noted that ESMA conducted a first round of on-site inspections of the three main rating agencies in December of  2011. This was done in order to get a better understanding of the rating process and to assess the regulatory compliance by rating agencies in this area.

An ESMA report with the main findings of these initial examinations, issued on March 22, 2012, identified several shortcomings and areas for improvement that apply, to a varying extent, to all three credit rating agencies relating to such topics as transparency and disclosure of rating methodologies and ratings, controls over IT systems, the recording of core internal processes, and the resources devoted to internal control functions and analytical business lines. ESMA is now following-up on the observations through risk mitigation plans for each individual rating agency, said the Chair.

As part of its on-going regulation, ESMA is required to ensure that methodologies are rigorous, systematic, continuous, and subject to validation based on historical experience, including back testing. However, the CRA Regulation prevents ESMA from interfering with the content of credit ratings or methodologies. This also applies to the European Commission and any public authority of a Member State.

Chair of China Securities Regulatory Commission Details Efforts to Open Up Financial Markets


How to combine safety and convenience as well as stability and flexibility has become the major theoretical and practical issue faced by the reform and opening up of China’s securities and capital markets, said Guo Shuqing, Chairman of the China Securities Regulatory Commission. In recent remarks at the IOSCO Annual Conference, he noted that China has embarked on a unique and multi-pronged approach to opening up its capital markets involving the reform of state-owned enterprises; special regimes such as the Hong Kong Special Administrative Region playing the double role of bridge and barrier for capital inflow and outflow; and opening securities markets to overseas participants in a gradual and indirect manner. A signal goal of the reformed regulatory regime is to attract foreign direct investment.


According to Chairman Guo, a number of thoughtful arrangements were adopted in furtherance of the opening up, including prioritizing “greenfield investments”, guiding the financial industry to serve the real economy, effectively establishing the firewall system, adopting a gradual approach by starting the opening up from foreign-related economic sectors. In his view, these arrangements have maintained the sound and steady development of China’s economy and finance in general. However, he acknowledged the existence of some drawbacks, such as the imbalanced development of capital and financial market systems and the yet-to-be-improved market operation efficiency and the effectiveness of financial regulation.


The Chairman also emphasized that there is no absolute and one-size-fits-all standard for capital accounts convertibility. Therefore, countries with different development levels must take their respective path of opening up and particular circumstances into consideration. He pointed out that the concept of  fully free convertibility does not exist in reality; and should be considered in a prudent manner. In any country, he reasoned, capital account convertibility does not translate into total abandonment of regulation and control.

ESMA Executive Director Emphasizes Importance of Cross-Border Convergence of Derivatives Regulation


As the EU finalizes the regulation of OTC derivatives this year, it is important that there be cross-border harmonization and convergence with the derivatives regulatory regimes of other jurisdictions, said Verena Ross, Executive Director of the European Securities and Markets Authority. In recent remarks, she noted that there is no alternative to close international cooperation, both in the setting of standards and in the execution of day-to day-supervision, if regulators and policymakers want to achieve an efficient system for the global financial markets. Since no single regulator can seek to regulate global financial markets from one location, she reasoned, regulators will need to rely on equivalence, mutual recognition and cooperation in order to make progress.

In coordination with the European Commission, but also in close cooperation with national regulators, ESMA plays a central role in ensuring that Europe speaks with one voice vis-à-vis regulators outside the European Union. The Executive Director pointed out that a main reason for cross-border regulatory convergence is to avoid regulatory competition whereby regions end up with fundamentally different, and potentially lower standards and ultimately a more risky environment for everyone.

The initiatives related to OTC derivatives are a good example of this need for convergence and cooperation at a global level. In Europe, the result from the G20 commitments has been the European Market Infrastructure Regulation (EMIR), and to a degree the provisions on derivatives transparency in MiFID 2. The same issues are occupying EU counterparts in the US and Asia.

EMIR introduces a reporting obligation for OTC derivatives, a clearing obligation for eligible OTC derivatives, measures to reduce counterparty credit risk and operational risk for non-cleared OTC derivatives, common rules for central counterparties and for trade repositories, and rules on the establishment of interoperability between central counterparties.

Now that EMIR has now been agreed upon by the European Parliament and the Council, noted Ms. Ross, ESMA is due to deliver draft regulatory and implementing technical standards under EMIR. Indeed, the EMIR standards will dominate ESMA’s agenda for the next months in view of the number and complexity of the technical standards to be delivered. There will be around 40 standards, said the ESMA official, and most of them will require careful consideration and often difficult judgments to be taken.

Regarding the derivatives regulations and standards, ESMA intends to publish a consultation paper in June and hold a public hearing in July to take the work forward. Since EMIR and ESMA’s technical standards contain major changes for financial markets participants, the official hopes that there will be active public engagement in the upcoming consultation, despite the fact that due to a deadline of the end of September ESMA will need to conduct the consultation during the summer.

ESMA is due to deliver the standards to the European Commission by the end of September. It is expected that the Commission will endorse them by the end of the year, to ensure that the EU meets the G20 commitments on moving OTC derivatives markets to be centrally cleared. At the Pittsburgh Summit in 2009, the G20 leaders agreed that by the end of 2012 all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties, that OTC derivative contracts be reported to trade repositories, and that non-centrally cleared contracts be subject to higher capital requirements.


Florida Fingerprint Card Processing Fee Reduced

The Florida fingerprint card processing fee for applications received on or after May 29, 2012 is reduced to $40.50, from $43.25. Applications received before May 29 require the $43.25 fee.

Monday, May 28, 2012

Incoming CEO of UK Financial Conduct Authority Says Dangerously Risky Financial Products Could Be Banned


The incoming head of the UK Financial Conduct Authority said that the new regulatory regime replacing the Financial Services Authority will be forward-looking and actively seek out potential issues and deal with them, rather than letting them snowball and allowing problems to build up. In recent remarks, Martin Wheatley said that the FCA will look closely at the financial products being designed and provided and, in extreme cases, use new regulatory powers to ban products first, before consulting. More broadly, he emphasized that the Financial Conduct Authority will ensure that focus and commitment towards the end consumer is taken seriously by all the financial firms it regulates, large or small.

For the first time, he noted, the UK will have two distinct financial regulators: the FCA, which will aim to make sure consumers get a fair deal from all financial firms; and the Prudential Regulation Authority, which will ensure that banks and insurers are financially sound. Mr. Wheatley is currently the Managing Director of the Financial Services Authority and CEO-designate of the Financial Conduct Authority, The FSA will be replaced by the Financial Conduct Authority and the Prudential Regulation Authority in 2013
The Director said that financial regulators must move on from the view that transparency at the point of sale was all that was needed, and that the regulator did not need to question business models.  In his view, this approach has proven insufficient time and again in getting good outcomes for people.  There are many reasons for this, he noted, such as consumers being asked to take more important financial decisions for themselves but finding financial services confusing, and firms being under intense pressure to bring in profits in a competitive environment and challenging economic times. 
He emphasized that the FCA will expect senior management and board of directors to understand all of their business and the risks.  This will be especially true if the firm is thinking of new areas to go into to grow the bottom line. It is important to manage conduct risks in financial firms, particularly in respect of new business.
He pledged that the FCA will treat everyone the same, big or small. The FCA will expect all financial firms to give consumers a fair deal. While the FCA we will recognize the differences in the complexity of firms and their business models, the new authority will hold all firms to the same high standards. The FCA will expect the senior management and boards of all firms, whatever their size or structure, to help the authority meet its goal of making markets work and getting a fair deal for consumers.

KPMG-AIMA Study Finds Institutionalization of Global Hedge Fund Industry and Concern over the Severe Impact of FATCA


A joint study by a Big Four accounting firm and a global hedge fund association reveals that since the advent of the financial crisis, new capital coming into hedge funds has been largely from institutional investors, with the majority of assets under management now coming from pension fund and other institutions rather than from high net worth individuals and family offices. Because institutional investors are extremely demanding in terms of due diligence and require robust operational infrastructure in the fund managers they allocate to, said the study, hedge fund managers have strengthened their own infrastructure. And because these institutional investors seek increased transparency, hedge fund managers have increased their emphasis on transparency and due diligence. The study was a joint effort of KPMG and the Alternative Investment Management Industry.

All this has been happening in the context of a major wave of new post-crisis regulation impacting the industry. While the hedge fund industry accepts that increased regulation is here to stay, found the study, the industry would hope to see cross-border regulatory convergence and harmonization. Globally, regulators have been working toward a G20 agenda of introducing new registration and reporting rules for hedge fund managers, with the Alternative Investment Fund Managers Directive in the European Union and the Dodd-Frank Act in the United States, with both seeking to increase the flow of information from hedge fund managers to regulators. Changes to the regulations around short-selling and OTC derivatives clearing have also significantly impacted hedge fund managers.

But the study said that the wide-reaching Foreign Account Tax Compliance Act (FAT CA) is likely to severely impact the global hedge fund industry. FATCA is aimed at preventing offshore tax abuses by US persons. The legislation requires every foreign financial institution (FFI) to enter into an agreement with the Internal Revenue Service whereby the FFI commits to identifying US accounts and reporting them annually to the IRS. Hedge funds and managers will be captured by FATCA, said the study, since it impacts all domestic  and foreign financial institutions that make and/or receive withholdable payments or are in the same expanded affiliated group as an entity that makes and/or receives withholdable payments.

Non-compliance with FATCA will result in what the study called a ``penal withholding regime’’ (30 percent) on foreign entities that refuse to identify and report US persons. The study found that this regime would put severe commercial pressure on non-participating hedge fund managers, those not entering into agreement with the IRS, in terms of investing into the US for either themselves or their customers and investors; thereby damaging customer relationships and reducing business opportunities.

FATCA is expected to impact hedge funds in a number of ways. Counterparties are likely to demand all FFIs be compliant in order to guard against the contingent risk that a hedge fund’s control environment is not sufficiently robust to guarantee it will never have the slightest exposure to US assets or clients. Hedge funds will need to identify their US account holders and demonstrate the rest are not US taxpayers. In addition, withholding rules require that the hedge fund must have the systems and process capability to identify and withhold tax on payments to entities or people who are not in good standing in the regime. This may present significant technical challenges for hedge funds.

42%
58%

SEC Official Provides Checklist for Newly Registered Hedge Fund Advisers

Hedge fund advisers newly registered with the SEC pursuant to the mandate of the Dodd-Frank Act should undertake a comprehensive review of their operations to identify any gaps in their control and compliance policies and procedures, noted Norm Champ, Deputy Director, SEC Office of Compliance Inspections and Examinations. In recent remarks before the New York City Bar, he also advised hedge fund advisers to update their policies and procedures when there are changes in the firm’s activities or products. They should also assign responsibility to specific persons for maintaining the procedures. In addition to reviewing policies and procedures annually, which is required under Advisers Act Rule 206(4)-7, the SEC official urged hedge fund advisers to periodically test and verify procedures. For example, they should test and verify valuation procedures for consistency, especially for complex or illiquid securities.

Title IV of the Dodd-Frank Act eliminated the private adviser exemption and required hedge fund and other private fund advisers to register with the Commission. The staff has been monitoring the Form ADV applications of new advisers as they have been filed, noted the Deputy Director, and believes that 48 of the 50 largest hedge fund advisers in the world are now registered with the SEC.

In addition, hedge funds and other private equity funds with at least $150 million in assets under management must file a new Form PF. The information reported in Form PF will be used by the Financial Stability Oversight Council to monitor risks to the U.S. financial system and by the SEC to conduct risk assessments of private fund advisers. All investment advisers required to file a Form PF must provide basic information in Sections 1a and 1b.


Large private fund advisers must provide more detailed information than smaller advisers. Most hedge fund advisers must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after December 15, 2012. Hedge fund advisers, with at least $5 billion in assets under management attributable to hedge funds, must begin filing Form PF following the end of their first fiscal year or quarter, as applicable, to end on or after June 15, 2012.
Smaller hedge fund advisers will be required to file only annually within 120 days of the end of their fiscal year. Large hedge fund advisers will be required to file quarterly, within 60 days after the end of each fiscal quarter.

Form PF may require voluminous data, cautioned the Deputy Director, and hedge fund advisers may find that they do not maintain or collect all of the information that is required. Much of the information may be located in various places throughout the firm and some effort may be required to collect and report the information. He thus suggested that hedge fund advisers begin now to identify the sources within the business where the data resides, determine how best capture such data, collect and compile the data, and assure its accuracy.

Continuing down his checklist, the SEC official more broadly urged hedge fund advisers to identify risk and brainstorm any factors that create risk exposure for their clients and their firms. They should also ensure that their employees are knowledgeable about their work and that the adviser has sufficient expertise to oversee what goes on. Hedge fund advisers should continue to update and train their employees about new rules and procedures applicable to the firm and its products.

The Deputy Director asked hedge fund advisers to be aware that SEC examiners may verify some or all of their assets and could reach out to third parties and possibly clients in this process. In this regard, hedge fund advisers should make sure that their organization has done adequate due diligence in connection with third parties, including consultants and service providers.

The official urged hedge fund adviser to get rid of silos and open communication among divisions and offices where appropriate and legally possible. While aware that in some situations barriers between certain areas of a firm are required legally, he asked hedge fund advisers to identify any situations where their interests may conflict with those of their clients and ensure that these conflicts are managed and disclosed.

Similarly, hedge fund advisers should to ensure that they have made complete and accurate disclosure about performance, arrangements, fees, affiliates and affiliated transactions. Importantly, now that the JOBS Act permits general solicitation under Regulation D, said the official, hedge fund advisers should review marketing documents, client communications and questionnaire responses to ensure information is accurate and not misleading. They should also verify that fees are calculated correctly and accurately disclosed. The advisers should make sure that they can trust the information, both external and internal, upon which they rely.

Hedge fund advisers should also review client account holdings for appropriateness and review trades for unusual performance relative to peers and markets. They should also compare trades to restricted lists and determine if trades were made ahead of publicly available news or research reports.

With regard to complaints, hedge fund advisers should ensure that their procedures provide adequate instructions on handling them, and they should follow up to make sure that they have been resolved. The final item on the SEC official’s checklist is for hedge fund advisers to check their IT security to ensure that clients’ assets and information are not at risk.

 



Friday, May 25, 2012

Group Asks Federal Court to Order SEC Issuance of Regulations Implementing Dodd-Frank Sec. 1504; Senators Comment on Proposed Regs


International relief and development organization Oxfam America has filed a lawsuit in the US District Court for the District of Massachusetts asking the court to order the SEC to issue regulations implementing Section 1504 of the Dodd-Frank Act, which requires companies in the extractive industries to periodically disclose information pertaining to certain categories of payments made to the governments of the countries in which they operate. The group claims that the SEC has unlawfully delayed the issuance of the final regulations under Section 1504, known as the Cardin-Lugar provision after its two senatorial sponsors, Senators Ben Cardin (D-MD) and Richard Lugar (R-IN).

Congress set a deadline of April 17, 2011 for the SEC’s promulgation of the final regulations needed to effect the Section 1504 mandate, noted the group, adding that the SEC has now missed this statutory deadline by over one year. In an April 16 letter to the SEC, Oxfam America said that it would file suit if the Commission did not issue a final rule within 30 days. The federal court complaint states that the extractive payment disclosures that Congress mandated nearly two years ago will not take place unless and until the SEC issues final regulations. Unfortunately, said the group, the SEC’s pattern of delay gives no assurance that it will ever promulgate final regulations without the involvement of a federal court.

In its April 16 letter, the group claimed that the Commission's failure to issue final regulations implementing Section 1504 places the agency in violation of the Administrative Procedure Act, which requires agencies to conclude matters presented to them with due regard for the convenience and necessity of the parties and in a reasonable time. The group further claims that this lapse constitutes unreasonable delay and unlawful withholding of agency action actionable under Section 706(1) of the APA.

In a January 31, 2012 letter to the SEC, Senator Cardin, along Senators Charles Schumer (D-NY) Patrick Leahy (D-VT), Carl Levin (D-MI) and John Kerry (D-MA), expressed concern that final regulations implementing  Section  1504 had not yet been adopted. They cautioned that to repropose the regulations at this point would violate the clear statutory deadline provided by Congress.

The Senators emphasized that Section 1504 is critical to providing information of great value to investors as they assess the commercial, political and reputational risk faced by companies in often volatile locations. In addition, the greater transparency will discourage corruption, reduce conflict and enhance stability, secure energy supplies, and ensure a more predictable operating environment for extractive companies. They pointed out that investors with over $1 trillion in assets under management wrote to the SEC in support of strong rules, including the largest public pension fund in the United States, and asset managers for the third largest pension fund in Europe.

The Senators urged the SEC to resist pressure to release weak regulations that do not follow the clear statutory language and legislative intent of Section 1504. To accurately reflect the letter and intent of the law, they emphasized, the final regulations should apply to all countries and companies with no exemptions. They should also define the terms project and payment in ways that do not create reporting loopholes, particularly with regard to the threshold amount for reporting.

Moreover, the SEC should require the compilation of the payment data to be in addition to, and not in lieu of, the data produced by companies. The Senate leaders said that reporting data that is of high quality, and understandable and usable for investors and the general public is crucial to the efficacy of Section 1504. For this reason, requiring issuers to "file" the Section 1504 disclosures, which would provide investors with a private right of action, would not only complement the SEC's own enforcement efforts, but would lead to more accurate and reliable data.

Further, any exemptions, including exceptions for conflicting host country laws, would not only encourage other countries to enact laws reducing transparency and start a race to the bottom, the Senators warned, but would also create a dangerous precedent by making the U.S. lawmaking process subservient to governments around the world, including dictators who do not share a commitment to transparency, good governance, and the rule of law. Such an exemption would not only distort the plain meaning of the law, but would also undermine the Congressional intent and the spirit of Section 1504.

In a separate letter to the SEC, Senators Lisa Murkowski (R-Alaska) and John Cornyn (R-TX) said they were troubled that the SEC’s proposed definition of ``project’’ could result in US companies disclosing information allowing foreign state-owned oil companies an unfair competitive advantage for operations in the host country. The Senators said that Section 1504 authorizes the SEC to define ``project’’ in a way that promotes international transparency while protecting US companies from competitive harm.

They posited that a definition of ``project’’ allowing companies to aggregate data from multiple agreements in a particular country, geologic basin, or province would mitigate the potential for competitive harm. In addition, the Senators said it is imperative that the final regulations require disclosure of payments only for material projects and allow an exemption for operations in countries prohibiting the disclosure of payment information. Without this exemption, warned Senators Cornyn and Murkowski, US companies could be forced to shut down profitable operations.

Mortgage-Backed Securities Working Group Sets Up Whistleblower Hot Line; SEC Enforcement Director Details Efforts


The Residential Mortgage-Backed Securities Working Group has launched a whistleblower website to report fraudulent activities in the mortgage-backed securities market. The Working Group wants to hear from people who worked in the RMBS market who acted responsibly but who also may have witnessed greed and misconduct that crossed the legal line and created havoc for investors and the economy. 

The SEC’s Office of the Whistleblower said that the Working Group is particularly interested in information about residential mortgage-backed securities fraud from corporate insiders who worked in the industry and witnessed the misconduct.  Fraud can be hard to uncover without help from whistleblowers who were corporate insiders, noted the SEC, adding that the Working Group has the ability to pursue fraud even when it occurred several years ago. 

The Residential Mortgage-Backed Securities Fraud Working Group is part of the Financial Fraud Enforcement Task Force, which was set up by President Obama in November 2009 to hold accountable those who helped bring about the financial crisis as well as those who would attempt to take advantage of the efforts at economic recovery.The RMBS Working Group is a collaborative effort led by five co-chairs including the SEC Enforcement Director and state and federal prosecutors. The Working Group and its members are focused on investigating potential false or misleading statements, deception or other misconduct by market participants in the creation, packaging and sale of mortgage-backed securities.


The RMBS website is a new call to those insiders who know about fraud that occurred in the RMBS market, who know it's time to expose that fraud, and who want to help the Working Group hold accountable those individuals and institutions who broke the law in pursuit of bigger paydays,  said Acting Associate Attorney General Tony West.  He added that whistleblowers enjoy legal rights that protect their ability to speak out without the fear of retaliation.  He pledged that the Working Group will do everything it can to maintain the confidence and trust of whistleblowers  who come forward.

The approach to RMBS investigations is systematic and smart, noted Co-Chair and SEC Enforcement Director Robert Khuzami, with cross-agency teams comprised of experienced prosecutors and investigators utilizing market experts and risk-based criteria to triage transactions for review, and bringing to bear the entire palette range of state and federal legal theories and remedies.  The SEC Director said that the numbers reveal the Working Group’s effort and commitment, with the SEC alone bringing to the effort more than 40 SEC staff from eight offices trained in securitized products. 

The SEC teams bring substantial ongoing investigatory work to the effort as well.  Since 2010, he observed, the SEC has issued over 300 subpoenas or document requests resulting in more than 30 million pages of documents with interviews or sworn testimony taken from over 180 witnesses, all focused on whether firms failed to disclose important information when selling residential mortgage-backed securities.

PCAOB Disciplined Audit Firm and Auditor Involved with Audits of China-Based Companies


A registered audit firm was censured by the PCAOB and its registration was revoked for at least two years based on finding that it failed to comply with PCAOB quality control standards in the audits of the financial statements of China-based companies. Without admitting or denying, the findings the firm also consented to the imposition of a civil money penalty. (In the Matter of Brock, Schechter & Polakoff, PCAOB Release No.105-2012-002, May 22, 2012)

The Board found that the firm failed to develop policies and procedures sufficient to provide it with reasonable assurance that the firm undertook only those public company audit engagements that it reasonably could expect to complete with professional competence. When it began auditing the financial statements of public companies located in the Republic of China and the People's Republic of China, said the Board, the audit firm had no prior experience auditing public companies pursuant to PCAOB auditing standards, and had no prior experience auditing companies based in Taiwan or China. Despite its lack of professional staff with relevant training or experience, the firm accepted the engagements to audit the companies’ financial statements.

The Board also found that the audit firm failed to develop quality control policies and procedures sufficient to ensure that the audit personnel assigned to work on public company audit engagements, including the auditor with final responsibility, possessed the degree of technical training and proficiency required to fulfill their engagement responsibilities. Moreover, the firm’s monitoring program, which failed to select any of the audit firm’s public company audit engagements for review, was insufficient to provide the firm with reasonable assurance that its system of quality control was effective at assessing whether the firm's audits were performed in compliance with applicable professional standards.

In addition, the audit firm failed to comply with PCAOB auditing standards related to the planning, performance, and supervision of the audits. The Board found that the audit firm failed to gather sufficient competent evidential matter, and failed to use due care and to exercise professional skepticism in the course of the audits. The audits were planned and performed by two other audit firms, one located in Taiwan and one located in China, not by the audit firm. During the audits, the audit firm had minimal contact with the foreign firms, said the Board, and performed an inadequate review of the working papers they prepared. The audit firm also failed to comply with PCAOB Auditing Standard No. 3 on audit documentation by failing to ensure that it obtained and reviewed engagement completion documents from the foreign firms prior to issuing audit reports.

In a separate proceeding, the Board barred the audit firm’s Director of Accounting and Auditing from the industry for at least two years for violating PCAOB rules and auditing standards in connection with the audits of three China-based and Taiwan-based issuer clients, and the improper creation, addition, and backdating of audit documentation prior to a Board inspection. The Director, who was the auditor with final responsibility for the audits of the financial statements of each of the issuers, settled the action without either admitting or denying the Board’s findings. (In the Matter of James R. Waggoner, CPA, PCAOB Release No.105-2012-003, May 22, 2012)

The auditor failed to comply with PCAOB auditing standards related to the planning, performance, and supervision of the audits. The Board said that he also failed to gather sufficient competent evidential matter, and failed to use due care and to exercise professional skepticism in the course of the audits. In addition, the auditor failed to comply with Auditing Standard No. 3 by failing to ensure that the firm obtained and reviewed engagement completion documents from the foreign firms prior to authorizing the firm to issue the audit reports.





Thursday, May 24, 2012

Kansas Waives Surety Bond Requirement for Investment Advisers

Investment advisers having custody of, or discretionary authority over, their clients' funds or securities are no longer required to maintain a surety bond. The minimum $35,000 surety bond requirement was waived by administrative order of the Kansas Securities Commissioner, effective May 21, 2012.

Wednesday, May 23, 2012

NYSE Panel Urges Reform of Proxy Distribution Fee Structure; Proposal to SEC Expected


The NYSE Proxy Fee Advisory Committee has filed a report recommending changes to the fees paid by public companies to banks and brokers for the distribution of proxy materials to shareholders who hold their stock in street name.  Composed of issuers, broker dealers and investors, the PFAC was formed in September 2010 to review the existing proxy distribution fee structure and make recommendations for change. The NYSE will initiate discussions regarding the PFAC's recommendations with the SEC, after which the NYSE expects to submit a rule change proposal to the SEC reflecting the outcome of these discussions.
The goals of the Committee have been to support the current proxy distribution system, including continued support for the elimination of mailings; to facilitate active voting participation by retail beneficial owners; improve transparency of the fee structure and ensure that fees are as fair as possible and aligned with the work involved. Overall, the Committee urges the streamlining of proxy fees and making them more transparent to issuers.
Proxy distribution fees have been part of the NYSE's rules since 1937, and have been reviewed and changed periodically over that time, said Scott Cutler, Co-Head of U.S. Listings and Cash Execution and member of the Committee.  The NYSE has long operated under the assumption that these fees should represent a consensus view of the issuers and the broker-dealers involved. 
Specifically, the Committee recommends streamlining into three basic proxy fee categories: a nominee fee, a basic processing fee and a preference management fee. This is designed to increase transparency. The Committee seeks a gradual tiering of the basic processing fee to smooth the cliff effect that occurs between large and small issuers.  


The Committee also recommends reducing the preference management fees for managed accounts to half the normal rate, and eliminating processing fees for managed account positions of five shares or less. The processing fees for special meetings and contests would be modestly increased.

The Committee seeks to reduce by half the fee for annual meeting reminder notices, to support improved shareholder communication. The Notice & Access fees would be subjected to the proxy fee rules.

The PFAC also urged the NYSE to discuss the proposal to create an investor mailbox as a possible means to increase voting participation by retail shareholders with additional industry representatives so it can be determined whether the proposed "success fee" is at an appropriate level.  Finally, the Committee asks the NYSE to create an ongoing process to review proxy fees and services more frequently going forward.

It should be noted that the Committee's fee recommendations do not attempt to take into account potential changes to SEC rules that are discussed in the 2010 SEC Concept Release on the U.S. Proxy System, which has come to be known as the “Proxy Plumbing Release”.

Among the many issues discussed in the Release are proxy distribution fees, and the SEC said that it appears to be an appropriate time for SROs to review their existing fee schedules to determine whether they continue to be reasonably related to the actual costs of proxy solicitation.

SEC rules require brokerdealers and banks to distribute proxy material to beneficial owners, but the obligation is conditioned on their being assured of reimbursement of their reasonable expenses. The SEC has relied on stock exchange rules to specify the reimbursement rates, and it has been the NYSE rules that have established the standard used in the industry.

The Proxy Plumbing Release notes that it is a relatively simple process for an issuer to send proxy materials to registered owners of its securities because their names and addresses are listed in the issuer’s records, but the process of distributing proxy materials to beneficial owners is more complicated. Securities intermediaries such as banks and brokers hold securities for their customers, and there can be multiple layers of intermediaries for just one beneficial owner, presenting challenges in the distribution of proxy material.