Thursday, February 28, 2013

Bi-Partisan House Legislation Would Clarify that Dodd-Frank Municipal Advisor Registration Does Not Include Banks and SEC-Registered Entities

Bi-partisan legislation, H.R. 797,  has been introduced in the House by Rep. Steve Stivers (R-OH) and Gwen Moore (D-WI) clarifying that Section 975 of the Dodd-Frank Act requiring municipal advisors to register with the SEC does not include dealers, banks, investment advisers and members of municipal governing bodies, and others who were either already regulated before the enactment of Dodd-Frank or are appointed, volunteer public servants. The Municipal Advisor Oversight Improvement Act; by clarifying the Dodd-Frank Act’s definition for “municipal advisors,” will allow for more appropriate oversight and implementation by the SEC.

Everyone acknowledges that the Dodd-Frank definition for municipal advisors was too broad, said Rep. Stivers. The original language that defines municipal advisors includes people who are already regulated somewhere else, like volunteers on boards, bank tellers, attorneys, accountants, and other professionals. The intent of Congress in enacting Section 975 was not to impose a regulatory structure on previously unregulated entities that are active in the financial markets. The Municipal Advisor Oversight Improvement Act would clarify the Dodd-Frank Act’s municipal advisor definition to prevent financial market participants who do not advise municipalities from facing improper, duplicative, and onerous regulations under securities, banking, commodities, and other laws.

This bill is very similar to legislation, H.R. 2827, passed by the House during the 112th Congress with unanimous support. After being voted out of the Financial Services Committee by a vote of 60-0, H.R. 2827 passed the House by voice vote. According to then Ranking Member Barney Frank (D-MA), the SEC supports the bill as approved by the full Committee. H.R. 2827 was never taken up in the Senate. However, there is every expectation that the legislation will receive serious Senate consideration in the 113th Congress given that Senate Banking Committee Chair Tim Johnson (D-SD) recently indicated that the Committee is willing to consider bi-partisan changes to the Dodd-Frank Act.

The then full Committee Chair, Rep. Spencer Bachus (R-ALA), expressed concern over the scope of Section 975. While he supports efforts to police this segment of the  municipal market, Rep. Bachus, who is currently Chairman Emeritus of the Committee, believes that Section 975 and the SEC proposed regulations implementing the statute are overly broad and would require appointed, non-ex-officio municipal board members and officials to register with the SEC. In an earlier letter to the SEC, he said that the broad definition of municipal financial products combined with the failure to define ``advice’’ would also result in thousands of bank employees conducting routine business with municipal entities having to register with the SEC.

According to Rep. Moore (D-WI), a cosponsor of the bill, HR 2827 eliminates confusion around the SEC proposed regulations implementing Section 975. The definition of municipal advisor is the heart of the legislation. It is an exclusionary definition that creates certainty for market participants. HR 2827 also created a federal fiduciary standard for municipal advisors with no blanket exemptions. The bill specifies that municipal advisors have a fiduciary duty to their municipal entity clients and specifies when such duties begin and terminate in relation to municipal advisor activities. The legislation specifies that municipal advisors could engage in principal transactions with their clients, subject to MSRB regulation. This is consistent with the fiduciary duty that applies to registered investment advisors.

ESMA Calls for Code of Conduct for Proxy Advisory Firms

ESMA has called for a Code of Conduct for proxy advisory firms.  Proxy advisory firms are typically retained by mutual fund and hedge fund asset managers, pension plans, and other institutional investors to provide voting recommendations and otherwise assist in voting by these institutional investors, which range widely in size of assets under management.

ESMA suggested that the Code establish the principle that proxy advisors should seek to avoid conflicts of interest with their clients. Where a conflict effectively or potentially arises the proxy advisor should adequately disclose this conflict and the steps which it has taken to mitigate the conflict, in order that the client can make a properly informed assessment of the proxy advisor’s advice.

Another principle that should be embodied in the Code is that proxy advisors should provide investors with information on the process they have used in making their general and specific recommendations and any limitations or conditions to be taken into account on the advice provided so that investors can make appropriate use of the proxy advice.
Proxy advisors should also disclose both publicly and to client investors the methodology and the nature of the specific information sources they use in making their voting recommendations, and how their voting policies and guidelines are applied to produce voting recommendations. Proxy advisors should also be aware of the local market, legal and regulatory conditions to which issuers are subject, and disclose whether and how these conditions are taken into due account in the proxy advisor’s advice.

Proxy advisors should inform investors about their dialogue with issuers, and of the nature of that dialogue. Proxy advisors currently have no legal obligation to dialogue with issuers. But if they decide to dialogue with issuers, they should disclose it, including the nature of the dialogue and its outcome.

Senator Warner Introduces Bi-Partisan Legislation Requiring SEC and Other Independent Federal Agenies to Conduct Cost Benefit Analysis of Regulations

Senator Mark Warner (D-VA), a key member of the Banking Committee, and Senator Jerry Moran (R-KN) have introduced legislation requiring the SEC and other independent federal agenies to conduct a cost-benefit analysis of significant regulations. which the Startup Act 3.0, S. 310, defines, in the alternative, a regulation with a $100 million impact on the economy or a regulation that materially adversely impacts a sector of the economy, jobs or competition, or a regulation that creates a serious inconsistency or otherwise interferes with an action by another agency. Under the bill, the SEC and other independent regulators would have to conduct a cost-benefit analysis that includes an assessment of the benefits perceived from the propopsed regulation and an assessment of the costs of the proposed regulation, including the costs to the federal government to administer the regulation and the cost of companies to comply with it. There must also be an assessment of the cost and benefits of any reasonably  feasible alternatives to the proposed regulation and why the proposed regulation is preferable to these alternatives.

The legislation also requires the SEC Chair and other agency heads to conduct a review of proposed significant rulemaking and submit the results of that review to the appropriate congressional oversight committees which, in the SEC's case would be the Senate Banking Committee and the House Financial Services Committee. The review must also be posted on a public website. The review must examine, among other things, the problem the proposed regulation is intended to address and the impact of the regulation on the ability of new businesses to form and expand. The review must also identify and conflicting or duplicative regulations.

Monday, February 25, 2013

Contour of Dodd-Frank Corrections Bill Begins to Emerge in 113th Congress

With the reintroduction of legislation exempting inter-affiliate swaps from regulation under Title VII of the Dodd-Frank Act, and legislation clarifying the scope of SEC municipal advisor regulation under Section 975 of Dodd-Frank, the contours of a Dodd-Frank corrections bill begin to appear. Both of these pieces of legislation passed the House in the 112th Congress with overwhelming bi-partisan support. And again, in the 113th Congress, these measures are receiving overwhelming support. While thdese and other bi-partisan Dodd-Frank corrections bills died in the Senate in the 112th Congress, it is likely that they will be taken up by the Senate this year.

Senator Mark Warner (D-VA) presaged this in December of 2012 when he said, in remarks at the Bipatisan Policy Center, that the Senate would take up a bi-partisan Dodd-Frank corrections bill in 2013. A 2500 page piece of legislatikon like Dodd-Frank will be in need of corrections, said Senator Warner, who is a key member of the Banking Committee and a author and co-author of a numberf of Dodd-Frank provisions. In addition, Senate Banking Committee Chair Tim Johnson (D-SD) said that the Commitee will consider changes to Dodd-Frank if they have strong and overwhelming bi-partisan  support. As more and more bi-partisan bills emerge, such as one codifying the end-user exemption from some Title VII requirements, the momentum for a Dodd-Frank corrections bill will become inexorable and irresistable.

Friday, February 22, 2013

House Legislation Would Raise SEC Reporting Threshold from 500 to 2000 Shareholders for Savings and Loan Holding Companies

Bi-partisan House legislation has been introduced to raise the SEC reporting threshold for savings and loan holding companies from 500 to 2,000 shareholders and increase the deregistration threshold from 300 to 1,200. The Holding Company Registration Threshold Equalization Act, H.R. 801, is co-sponsored by Rep. Steve Womack (R-AR) and Rep. Jim Himes (D-CT).

Enacted on April 5, 2012, the JOBS raised the shareholder registration threshold from 500 to 2000 and increased the deregistration threshold from 300 to 1,200 for for banks and bank holding companies. Unfortunately, the JOBS Act did not explicitly extend the thresholds to savings and loan holding companies (SLHCs). However, the co-sponsors of H.R. 801 maintain that it was not the intention of Congress to treat SLHCs differently from bank and bank holding companies.

According to Rep. Womack, H.R. 801 extends the same flexibility to savings and loan holding companies ensuring that they, along with community banks across the country, can deploy capital throughout the communities they serve.”

The legislation will ensure that savings and loan institutions operate under the same rules as local banks,” said Rep. Himes. This will help S&Ls raise capital so they have the resources to make the loans consumers need to purchase homes, cars, and other large items they are more likely to finance than buy outright

The provision raising the thresholds for banks and bank holding companies was included in the Title VI. In 2012, the House Appropriations Committee included language in its report accompanying the Financial Services and General Government Appropriations bill that clearly evidences the intent of Congress to apply Title VI of the JOBS Act to S&L Holding Companies. That language says that “Congress intends for Title VI of the JOBS Act to apply to the S&L Holding Companies defined by the Home Owners Loan Act.

Tuesday, February 19, 2013

Legislation Exempting Inter-Affiliate Swaps Is Candidate for Dodd-Frank Corrections Bill

Rep. Steve Stivers (R-OH) has introduced legislation, H.R. 677, exempting inter-affiliate swaps from regulation under Dodd-Frank Act derivatives provisions. The legislation is bi-partisan and is cosponsored by Rep.Marcia Fudge (D-OH) and Rep. Moore (D-WI). The legislation would prevent internal, inter-affiliate swaps from being subject to costly and duplicative regulation. Similar legislation in the 112th Congress, H.R. 2779, passed the House by a vote of 357-36 in March 2012. The U.S. Senate did not take action on the proposal during the 112th Congress. This piece of legislation is an example of the type of legislation that would pass the test laid down by Senate Banking Committee Chair Tim Johnson (D-SD) as broad bi-partisan legislation amending Dodd-Frank that the Senate would consider as part of a corrections bill.

Sunday, February 17, 2013

Senate Legislation Would Close Carried Interest and Derivatives Blended Rate Loopholes in Federal Tax Code

Legislation introduced by Senators Carl Levin (D-MI) and Sheldon Whitehouse (D-RI) would close the carried interest and derivatives blended rate loopholes in the Internal Revenue Code and end the excessive corporate tax deductions for stock options. Title IV of the Cut Unjustified Tax Loopholes Act, S. 268, would ensure that hedge fund managers and other investment managers would pay ordinary rates on all of their income from providing management services.

Taxation of Derivatives. Title VI of the Act would end the blended tax rate for derivatives. Since 1981, profits from derivatives, including commodity futures, have benefited from a more favorable blended tax rate. Specifically, a short term capital gain from these derivatives is taxed, not at the short term capital gains rate, but at a rate which is 60 percent long term capital gains and 40 percent short term capital gains, even if the derivatives are held for seconds. Normally, investments have to be held for at least one year to get preferential long term capital gains tax treatment.

According to Senator Levin, this blended rate loophole lowers the taxes on these derivatives by about 10 percent, which encourages commodity speculation and high frequency trading compared to investments in stocks, bonds, and other financial instruments subject to normal capital gains rules. 


Taxation of Stock Options. Title III of the legislation would end the excessive corporate tax deduction for stock options. Stock options are currently the only type of compensation where the federal tax code allows corporations to claim a bigger deduction on their tax returns than the corresponding expense on their financial statements. That approach enables profitable corporations to report higher earnings to shareholders, said Senator Levin, while using the stock option deduction to reduce or eliminate those earnings on their tax returns and pay little or no taxes.
Corporations are also generally precluded from deducting compensation above $1 million paid to any employee. However, stock option compensation is exempt from that limit. The legislation would ensure that corporations take stock option tax deductions at the time, and in an amount not greater than, the stock option expenses shown on their books; and stock options compensation is subject to the same tax deductibility cap as other forms of compensation.
The Act thus eliminates a loophole that has allowed large corporations to exploit what is in effect a federal subsidy that helps pay for the compensation awarded to their executives. When companies award stock options to their top executives, they are allowed under law to record that expense in two different ways. They report one amount to their investors on their annual financial reports. But they can report a much larger expense, often orders of magnitude larger, to the IRS, and claim a tax deduction for that much larger claimed expense.

FSA Enforcement Director Recounts Difficulty of Bringing Individual Actions Against Senior Officers


Pressed by the Parliamentary Commission on Banking Standards on why there have seen so few enforcement actions against senior officers involved in the financial crisis, U.K. FSA Director of Enforcement Tracey McDermott explained that there are some big issues of fairness and individual rights in relation to criminalizing bad business decisions. There are various stages along the spectrum in relation to business decisions, she noted, but it is a very big step to criminalize incompetence or negligence. On the other hand, recklessness is much more familiar to the criminal law, so it is less of an issue. You can be prosecuted for recklessness.

These cases will always be difficult, said the Director. The reality is that it is always going to be difficult to take cases against individuals when you are looking at issues of competence. It is also important to bear in mind the purpose of enforcement actions as opposed to other regulatory action.

To a question from Pat McFadden, M.P on whether the current enforcement system is fit for purpose, Director McDermott said that the system is fit for purpose. While there are issues around the ability to hold senior individuals to account, that is not due to the enforcement process not being fit for purpose.

Questioned as to why U.S. regulators have brought more enforcement actions, Director McDermott said that historically there has been a very significant difference in approach between the U.S. and the U.K., in that the U.S. has historically used enforcement far more actively as one of the tools that the regulator uses. But the U.K. has changed in that regard significantly over the past few years, and now uses its powers more formally.

The Director also mentioned that there has been a cultural difference between the U.S. and the U.K. as to the degree of formality in the way in which the regulator has engaged. A lot of the time in the U.K., if you can get an outcome without using formal powers, that would typically be the starting point, whereas in the U.S. the starting point would be that you would use formal powers. One of the issues there is that the use of formal powers might be something that is escalated more apparently to the board than if you are using a more informal arrangement, or the seriousness may strike home to the board. Again, there is a question of whether the FSA should use formal powers more frequently, as a supervisory tool rather than necessarily an enforcement tool.
The Director also noted that the big distinction between the FDIC’s actions and the FSA’s actions is that the FDIC’s constituents are largely smaller institutions. The U.S. has a significantly higher number of banks than the U.K. They are focused on the smaller institutions for which it is actually much easier to find evidence. That is a practical matter, because the chains of command are shorter. If you look at the larger US institutions, the ones that failed, such as Lehman’s, she noted, or those that were bailed out, there has not been any enforcement actions against the senior management of those institutions.
The Director rejected a suggestion from Lord McFall that the FSA has been the subject if regulatory capture. The FSA has attempted to hold people accountable and has not always succeeded at doing that and is looking to see how the agency can do that better, she averred, but it is unfair to say that that was due to regulatory capture or to a lack of integrity on the part of the FSA.
Asked by Lord McFall to define good corporate governance, the Director replied that good corporate governance would be an organization that is well run and well managed, in accordance with proper ethical and business corporate standards.
Whistleblowing. Commission Chair Andrew Tyrie asked about employing, similar to the SEC, a reward structure for whistleblowing that can enable whistleblowers to share in the fine. The U.S.has had that for a considerable period of time in relation to federal tax issues and for a much shorter time in relation to SEC regulatory issues. At the moment, replied the Director, the FSA does not think that there is a case made out for significant financial incentives for whistleblowers, but the US experience is something the agency would want to keep looking at.
It is a very interesting scheme, she conceded, and the FSA has talked to the SEC about how it is working. The position is that it is still a little too early for it to tell, within a regulatory context, how it works. In relation to the U.K, she continued, there are some particular cultural differences, in terms of the way in which the court system works and the value that is placed on whistleblower evidence, or evidence of co-operating witnesses. That is very different in the U.S., because U.S. courts are used to that, but it is not something with which the U.K. courts are very comfortable. There are also issues around moral hazard in terms of financial rewards, particularly if you are talking about, using LIBOR as an example, a situation in which you pay a well-paid derivative trader a large sum of money.

Pressed further by Chairman Tyrie on the need to transform whistleblowing into something that is going to be effective, Director McDermott did not think that financial incentives for whistleblowers would be the thing that significantly changes the effectiveness of whistleblowing. She added that the whistleblowing system is not defective. The whistleblowing system exists, she said, and, in terms of how we treat whistleblowers and act on that information, I think it is effective. In the Director’s view, a lot of things that get put under the umbrella of whistleblowing are actually not whistleblowing, rather they are self-reporting or action taken by individuals within firms on an open basis, which is not whistleblowing.

House Leader Introduces Legislation to End Too Big to Fail


Rep. John Campbell (R-CA), Chairman of the Financial Services Subcommittee on Monetary Policy, has introduced the Systemic Risk Mitigation Act, H.R. 613, to eliminate the problem of too big to fail. Currently, certain financial institutions, by nature of their size, scope and interconnectivity, are deemed  too big to fail as their potential insolvency would result in systemic economic collapse. Therefore, these institutions carry the implicit guarantee of massive, taxpayer-funded bailouts in the event of catastrophic failure. As a comprehensive reform measure, the Systemic Risk Mitigation Act would clearly articulate the lines between private sector risk and the taxpayers by means of significantly ratcheting up capital requirements for large financial institutions.

Too Big to Fail. According to Chairman Campbell, the legislation will disconnect the taxpayer from the implicit guarantee currently perpetuating a system built on future bailouts.  It will build a wall of private capital between the banking sector and the taxpayers. It will make the banking system more transparent, accountable, competitive, and stable.

The Systemic Risk Mitigation Act would set up a comprehensive regulatory structure requiring financial institutions to hold a second layer of capital for the purpose of minimizing the extent to which their failure would precipitate broader market and economic turmoil. Under this new structure, large financial institutions will be required to hold substantially more capital. In the event of a failure, investors will be explicitly denied any bailout and would only be repaid after all other systemically important and secured debts are satisfied.

Under the legislation, the Federal Reserve, in its role as a regulator of large financial institutions, would be required to monitor markets for signs of diminished confidence in an institution’s ability to satisfy claims by investors.  Should a financial institution become undercapitalized, the Federal Reserve would be empowered to intervene in order to notify the institution of the deficiency, conduct stress tests, and oversee the implementation of remediation plans. In the event that an institution is unable to raise sufficient capital, The Systemic Risk Mitigation Act would place it into receivership.

Importantly, this legislation gives financial institutions, not policymakers, the final decision on how they will decide to structure themselves. The Systemic Risk Mitigation Act does not force a financial institution to break itself up, but does require that it operate in a manner that is safe, accountable, and independent of any reliance on the U.S. taxpayer.      

German Legislation Creates Modified Proprietary Trading Ring-Fence for Retail Banks, Mandates Living Wills


The German Government has approved legislation separating commercial and investment banking on the basis of a modified ring-fencing approach embodied in the E.U. Liikanen Report. The legislation also provides for the winding up and reorganization of financial groups. Finally, the legislation provides for criminal liability for executives at banks and insurance companies should such executives violate their duties.
The legislation, which was presented by German Finance Minister Wolfgang Schäuble, contains important additional building blocks in Germany’s new regulatory framework for financial markets. Finance Minister Schäuble stated that the German Government is committed to ensuring that no financial market, stakeholder or product goes unsupervised. This legislation, continued the Minister, takes a head-on approach to the financial system’s lack of resilience to crisis as well as the lack of accountability.
Living wills for banks. The legislation creates rules for planning the reorganization and winding up of credit institutions and financial groups, so that preventative action can be taken in good time to help systemically important banks that have got into difficulties. The affected institutions will have to present reorganization plans so that in cases of doubt the authorities can act more quickly and obstacles to winding up an institution can be removed. The regulator will be able to demand that obstacles to resolution be eliminated even before problems arise.
This is an additional element that is required in order to effectively tackle the problem posed by having banks that are too big or too interconnected to fail. These are financial institutions that are so large and complex that they cannot be wound up without negative consequences for financial markets as a result of their high level of interconnectedness with other parts of the financial system.
The new law is designed to prevent the situation arising in the future where taxpayers are left to cover the costs of a bank collapse. This is also the objective of Germany’s Restructuring Act of 2010, which created instruments for orderly bank resolution including the bank levy and the Restructuring Fund. By taking this step, Germany will become one of the first E.U. countries to tackle the legislative implementation of this contingency planning for banks, known as living wills, that was agreed internationally at the October 2011 meeting of the Financial Stability Board.
The German Government will continue to play a constructive and committed role in the discussions relating to the E.U.’s Recovery and Resolution Directive that began in June 2012. However, the German Government wanted to take the lead by approving the draft law and is pressing forward with national regulatory arrangements, as in the areas of high frequency trading, short selling and fee-based investment advice.
Separation of banking activities. An important goal of the legislation is to enhance the protection of retail banking against risks arising from speculative activities. This will benefit retail customers and ultimately also taxpayers. The legislation largely follows the findings and recommendations of the E.U. Liikanen Report. The Report of the High Level Expert Group on E.U. Banking Reform (Liikanen Report) recommended that proprietary trading and other significant trading activities should be assigned to a separate legal entity if the activities to be separated amount to a significant share of a bank's business.

Under the German legislation, if certain thresholds are exceeded, deposit-taking institutions and groups that include deposit-taking institutions will no longer be allowed to combine in one entity deposit-related activities and proprietary trading, which is defined as the purchase or sale of financial instruments on the financial institution’s own account that is not a service for a third party. Instead, the financial institution will have to spin off proprietary trading into a company that is legally, economically and organizationally separate and that will require a license in accordance with Germany’s Banking Act.
Separating risky activities from retail banking will increase the solvency of an institution and contribute to the stabilization of financial markets. If a financial group exceeds the relevant thresholds, it will only be allowed to make loans to hedge funds and other comparable highly leveraged companies, or issue guarantees for their benefit, if it does so via the independent company that conducts its proprietary trading.
The thresholds, which are based on the recommendations of the Liikanen expert group, are as follows: The relative threshold is exceeded if assets associated with trading activities comprise more than 20% of the total balance sheet, while the absolute threshold is surpassed if trading-related assets are worth more than €100 billion.
The relative threshold is supplemented by a simple criterion which stipulates that only companies with total assets of over €90 billion will be affected by the rules. This is intended to ensure that the regime does not apply to an excessive number of smaller banks that would otherwise exceed the relative threshold. Additionally, a trading unit that has been separated off may not benefit from less stringent supervisory requirements that apply to other institutions in the same financial group.
However, deposit-taking credit institutions will still be able to carry out proprietary trading on behalf of their clients, such as to conduct the purchase and sale of financial instruments for their own account as a service for third parties, including market-making. The German Federal Financial Supervisory Authority, BaFin, will, however, be empowered to demand the separation of market-making activities in individual cases, so that it is able to deal with special circumstances.
Criminal-law provisions. Finally, the legislation tackles the issue of individual responsibility by significantly strengthening and clarifying the ability of the authorities to take criminal action in cases of severe breaches of duty that could get an entire bank or insurance company into difficulty. The legislation assigns specific responsibilities for risk management to senior managers at financial institutions. The violation of important risk-management duties will be punishable with a maximum of five years’ imprisonment should it threaten a firm’s viability as a going concern or if it jeopardizes insurance companies’ abilities to meet their obligations relating to insurance policies. These provisions create sanctions for mismanagement that will help to prevent future corporate crises and their associated negative effects on society and the economy.

Friday, February 15, 2013

IASB Chair Tells U.K. Parliamentary Panel that Dialogue between Outside Auditors and Financial Regulators Should Be Required


In testimony before the U.K. Parliamentary Subcommittee on Tax, Audit and Accounting, IASB Chair Hans Hoogervorst endorsed in principle the idea of a statutory requirement that outside auditors dialogue with financial regulators. Regulators don’t see anything, he said, despite all the leverage. For example, the IASB Chair believes that outside auditors were and probably are relying on the regulators to take care of going concern and, thus, were not so very critical. Outside auditors need to be more critical, he emphasized. While recognizing that auditors are in a very difficult position if they raise going concern issues in public, Chairman Hoogervorst said that they should raise going concern with the regulators.

Lord Lawson, Chair of the Subcommittee, said that during the financial crisis the independent auditors did leave it for the regulators, and yet the auditors were not speaking to the regulators. Equally, the regulator was not speaking to the auditors. It is common sense that they should be, posited Chairman Lawson, from the point of view of the regulator. It would be desirable, for example,  for there to be a statutory duty for the auditors of banks and the bank regulator to be in dialogue, so that auditors concerned about a bank can express their concerns to the regulator, and if the regulator is concerned about a bank, it can ask the auditor to look more deeply into it. Chairman Hoogervorst agreed that such a statutory duty would be helpful.
Chairman Hoogervorst also emphasized the need for global accounting standards. But Lord Lawson questioned how IFRS can be a global set of standards when the United States is going its own way with U.S. GAAP. The IASB Chair reaffirmed his belief, which has become a refrain, that the United States will come on board, but it will probably take a little longer than is desirable. The United States has had to decide on adopting IFRS in a very difficult economic time, he said, during the financial crisis. He wondered if the European Union would have been able to take such a position in the middle of economic upheaval.
Prudence. Referencing recent remarks by Chairman Hoogervorst, Lord Lawson said that the old definition of prudence that was written into accounting standards was spot on, but was removed to achieve convergence with US GAAP, which does not have prudence. Chairman Lawson noted that it is now clear that there is no need for convergence since the U.S. is going ahead with its own system. Therefore, he asked if that makes a conclusive case for writing prudence back into IFRS. Chairman Hoogervorst replied that putting the concept of prudence back into accounting standards would not make a fundamental difference. He pointed out that prudence was removed only in 2010, well after the outbreak of the crisis. In the period before the crisis, prudence was in the accounting standards.
He also said that the concept of prudence, which basically means that if you are in doubt about results, please be cautious, is still ingrained in the work of outside auditors. The reason why it was removed was because the IASB felt that it was being abused, or misunderstood, to underestimate artificially the value of assets, and the Board likes financial accounts to be as neutral as possible.
Expected Loss Model. Chairman Hoogervorst also noted that the Board is finalizing the expected loss model to replace the incurred loss model, which gave banks too much leeway to procrastinate about recognizing their losses and facing reality, which caused too low a level of provision. Under the expected loss model, banks will have to take some provisioning for all assets, even if they are not impaired. The trigger for taking a full lifetime loss will be much lower than in the current incurred loss model. Banks that have looked at the new model and have done calculations assume that their level of provisioning will go up, some say 30%, others say 100%, but it can safely be assumed that it will be quite substantial.
Finally, the IASB Chair noted that financial statement accounting will remain complex since the reality is extremely complex, especially with the different types of derivatives. Once you have derivatives, he observed, you have a lot of complexity. Regulators can do a lot to reduce it, but to eradicate it would be very difficult.



Senate Banking Committee Hearing Examines Regulatory Implementation of Dodd-Frank

A Senate Banking Committee hearing on the regulatory implementation of the Dodd-Frank Act focused on the need for regulatory coordination both domestically and cross-border and on the need for adequate economic analysis of the regulations. The Committee is Chaired by Senator Tim Johnson (D-SD).

Noting that proper economic analysis of the Dodd-Frank regulations is not happening, Senator Mike Crapo (R-ID), the Committee’s Ranking Member, asked for a commitment from the SEC, CFTC and the banking agencies that they would comply with the OMB guidance on cost-benefit analysis, which essentially codifies the President’s two Executive Orders in this area. Senator Crapo also asked the agencies to provide the Committee with information on the cumulative impact of all the Dodd-Frank regulations on participants in the financial services industry.

Senator Crapo and Senator Jack Reed (D-RI) expressed concern that the regulation of cross-border swaps may not be sufficiently coordinated. SEC Chair Elisse Walter said that the cross-border coordination of derivatives regulation is very important because these markets, more than others, cross international lines. Chairman Walter noted that the SEC is working with IOSCO and with its global regulatory counterparts who are writing derivatives regulations to coordinate the regulations. They are at different stages in the rulemaking process. CFTC Chair Gary Gensler noted that the European Union, with the recent enactment of EMIR, and Canada and Japan are completing the erection of derivative regulatory regimes, with these markets, along with the U.S., accounting for around 85-90 percent of worldwide derivatives transactions.

Chairman Walter favorably mentioned substitute compliance. CFTC Chair Gensler said that the doctrine of substitute compliance is embodied in the CFTC’s cross-border guidance. The proposed guidance is a balanced, measured approach, said the CFTC Chair, consistent with the cross-border provisions in Dodd-Frank and Congress’ recognition that risk easily crosses borders. Under substitute compliance, where appropriate, the CFTC is committed to permitting foreign firms and, in certain circumstances, overseas branches and guaranteed affiliates of U.S. swap dealers, to comply with Dodd-Frank through complying with comparable and comprehensive foreign regulatory requirements.


Senator John Tester (D-MT) asked Chairman Walter when the SEC would take action on a uniform fiduciary standard for investment advisers and brokers. Chairman Walter said that, while she believes it is the right thing to do and would like to move forward with it, opinion among the Commissioners varies a great deal. Senator Tester urged the SEC Chair to make this a priority, adding that it would help investors.

Senator Tester also noted that, with regard to the JOBS Act, the SEC has blown by statutory deadlines. He is troubled that implementation of the JOBS Act may not be a priority for the SEC. He urged the Commission to make progress implementing the JOBS Act so that small businesses can access the capital markets. Senator Tester reasoned that the full benefits of the JOBS Act cannot be realized until the implementing regulations are finalized.

Wednesday, February 13, 2013

Second Circuit Judges Question if Deference Was Paid to the SEC at Oral Argument in Citigroup Settlement Case


Oral argument was held before a Second Circuit panel reviewing a district court’s decision refusing to approve a proposed consent judgment between the SEC and Citigroup Global Markets, Inc. because it did not have adequate information to determine whether the proposed consent judgment was fair, reasonable, adequate, and in the public interest. The arguments were heard before Circuit Judges Pooler, Carney and Lohier.

Judge Lohier asked why in the world an Article III judge would try to control a consent decree process where there is a federal executive agency, the SEC, that has made its determination with vastly more facts available to it than the district court that this is a fair, adequate and reasonable settlement that is in the public interests. Judge Lohier said that the executive is in a better position to determine what is in the public interest.

John Wing, arguing for the district court, said that the district judge is obligated to review consent judgments and it is clear that there is an obligation on a district court, apart from the executive, to just review according to a standard that is well established. Fairness, reasonableness and adequacy are things that a court has to look at. It doesn't mean in every case or in most cases that there should be some extensive exploration of evidentiary facts. It may not be necessary for all sorts of reasons. This case really raised concerns because there were problematic issues, said Mr. Wing.

Judge Lohier queried why isn't it up to the SEC to determine the strength and weakness of its own cases. Sometimes, he continued, both on the civil side and criminal side, prosecutors and enforcement officials aspire to great things in connection with a particular case and determine, after more thinking and after the allegations are in the public arena, that a case is actually much weaker than they initially thought. Why then can't the SEC settle at what appears at first blush to be a substantial haircut from the allegations.

The SEC can, replied Mr. Wing. There is no question that the judge agrees that the SEC should be entitled to deference. But the judge is not limited to automatically saying I'll approve any consent judgment you bring me because you're the SEC and you're doing the public good. He has a standard that he has to apply and the standard is, can we say it's fair, reasonable and adequate.

Michael Conley, for the SEC, noted that courts that have looked at cases involving government agencies charged with responsibility for protecting securities laws that have negotiated at arms length with very capable counsel on the other side have given great deference to the agency's judgment of whether to settle.

Mr. Conley said that the Commission believes that the district court improperly failed to give any deference to the SEC in this case in its judgment that entering into a consent judgment here protects investors and the public interest, and, for that reason,  the decision should be reversed. When it refused to enter the consent judgment in this matter, continued Mr. Conley, the district court imposed a new bright-line rule under which it would not impose any consent judgment that includes injunctive relief unless the defendant admits the allegations.  SEC counsel noted that the Second Circuit has held that, where any settlement agreement is entered into at arms length by capable counsel, there is a presumption that it's fair, adequate and reasonable. And that presumption is heightened in circumstances like this where one of the parties negotiating the agreement is charged with responsibility for protecting the public interest through enforcement of the federal securities laws.

Judge Pooler asked why the SEC needs the injunction since it appears never to seek relief under any injunction the agency gets. Mr. Conley replied that, while it is true that the SEC rarely pursues contempt for violation of an injunction, part of that is because of the limitations on civil contempt where the misconduct has to be ongoing. However, the injunction also provides a good prophylactic remedy because of the potential for such actions. Moreover, the injunctions entered in these cases are the predicate for certain other collateral consequences which can also have a substantial remedial effect.

Brad Karp, arguing for Citigroup, noted that the SEC submitted a memorandum in support of the complaint. And then, Judge Rakoff asked the parties to respond to nine specific questions. The SEC put in a 28-page response laying out in detail the basis for the SEC's settlement, the consent judgment, the reasons for the injunctive relief, and the evidentiary support for the various components of the settlement including the disgorgement amount, the interest component, and the penalty. Citigroup put in a 23-page response to Judge Rakoff. Every question posed by Judge Rakoff was responded to fully and completely by both parties, emphasized Mr. Karp.

Mr. Karp also cautioned that many corporations will decide not to settle an enforcement action if a price of settlement is admitting liability or permitting a district judge to make a finding of liability in connection with a federal regulatory consent judgment. Nor would this court's ruling be limited to the SEC. There are more than 20 federal regulatory agencies that currently permit no-admit settlements. Mr. Karp warned that the federal regulatory enforcement regime would screech to a grinding halt if a majority of corporate defendants decided not to participate in settlements, but instead put the various federal regulators to trial.

Monday, February 11, 2013

Changes Proposed to German Corporate Governance Code Would Enhance Transparency of Management Remuneration


The Government Commission on the German Corporate Governance Code has proposed a number of changes to the Code to enhance the transparency and understanding of management remuneration. Specifically, the Commission is recommending that a cap be placed on remuneration, both in terms of its total amount as well as in terms of its individual components. In addition, the transparency and traceability of supervisory board remuneration decisions would be enhanced by supplementing the criteria that have already been outlined and have to be taken into account.
It is suggested, for example, that when defining a remuneration structure the supervisory board should consider the relationship between the remuneration of the management board as well as that of senior management and total staff, also in terms of its development over time. Within this context, a new recommendation should be incorporated stating that the supervisory board defines the targeted level of retirement provision for the management board and factors in the annual and long-term expense for the company arising from this.
In order to improve comparability over time and with other companies, both for the supervisory board and for the general public, the Commission recommends that important facts and figures on management board remuneration be prepared in a standardized fashion and that use be made of tables. Any burden of preparing the new tables is ameliorated by the fact that the data to be included in the proposed tables is already available to companies and is already published in one form or another to a large extent.
In the Commission’s view, consolidating and standardizing the way the data is presented will provide a better overview and improve comparability. In view of the potential organizational expense involved in the conversion, the recommendation regarding information in the remuneration report and the suggestion on the use of tables at companies would only be implemented beginning in 2014.

Friday, February 08, 2013

Praising ECOFIN Approval of Financial Transaction Tax, Senator Harkin Will Reintroduce U.S. Legislation


Praising the recent approval of a financial transaction tax for eleven E.U. countries by the Council of Economic and Finance Ministers, Senator Tom Harkin (D-Iowa) plans to reintroduce in the 113th Congress legislation to impose a financial transaction tax in the U.S. In the 112th Congress, Senator Harkin introduced the Wall Street Trading and Speculators Tax Act, S. 1787, which would have applied a three basis point tax or three cents on every $100 financial transaction. The EU financial transaction tax allows for a ten basis point tax on stock transactions and a one basis point tax for derivatives transactions.  Rep. Peter DeFazio (D-OR) will introduce a companion bill in the House.

Financial Transaction Tax. Under the Harkin legislation, for the tax to apply the purchase of the security must occur on a trading facility located in the U.S. and the purchaser or seller must be a U.S. person. The bill would exempt initial issues of securities and securities traded pursuant to certain lending arrangements. There will also be an exemption for retirement and education savings. The Act broadly defines ``derivative instrument’’ to include any option, forward contract, futures contract or any similar financial instrument.

According to Senator Harkin, the Congressional Joint Tax Committee scored their proposal as raising $352 billion over 10 years in the last Congress.   The lawmakers will reintroduce their measure in the coming weeks.

Fed Gov. Duke Applauds Differentiation of Community Banks in Post-Crisis Regulations

The differentiation of community banks in post-financial crisis regulations is appropriate, said Fed Gov. Elizabeth Duke. In remarks at a University of Georgia seminar, she said that community bankers have been successful in making the case against one-size-fits-all regulation. She noted that most of the regulations required by the Dodd-Frank Act are primarily directed at large systemically important banks. Also, many of the Act’s provisions specifically exempt community banks. For example, banks with less than $10 billion in total assets were exempted from a number of the debit interchange restrictions, and early studies indicate that those exemptions are working.

Community Banks. In addition, formal stress testing was required only for banks with total assets of $10 billion or more. In implementing these requirements for the larger banks, the bank regulatory agencies specifically indicated that capital stress testing would not be required for community banks. This does not mean that community banks are exempted from prudent risk management, cautioned the Fed Gov., but rather that smaller banks should think about the negative shocks that could affect their business in the future and tailor their risk-management procedures to the risks and complexities of their individual business models.

CFPB. The Consumer Financial Protection Bureau recently released final rules defining qualified mortgages that include safe harbors for mortgages that meet specific loan term and pricing criteria, including certain balloon loans made by community banks in rural or underserved areas. At the same time, they issued a new proposal that contains additional community bank exceptions, as well as a question about the treatment of loans to refinance balloon payments on mortgages that community banks may already have on their books.
Noting that smaller institutions have already demonstrated that they generally do a good job of servicing the loans they originate and that the investments necessary to meet the requirements would be unduly onerous for institutions that service a small number of loans, the CFPB also exempted most community banks from many of the provisions of new servicing requirements.

Governor Duke emphasized that such exceptions are especially important because Federal Reserve research has shown that community banks are important lenders in the mortgage market and those mortgage loans represent a significant portion of community bank lending, Also community banks are quite responsible in their practices.


Tuesday, February 05, 2013

Senate Legislation Would Block New Funds to CFPB Pending Confirmation of Director


In the wake of a DC Circuit opinion striking down the presidential recess appointments to NLRB members .Senators Mike Johanns (R-Neb.), Lamar Alexander (R-Tenn.) and John Cornyn (R-Texas) introduced legislation prohibiting the NLRB and the  Consumer Financial Protection Bureau (CFPB) from enforcing or implementing decisions and regulations without a constitutionally confirmed board or director. Richard Cordrey, CFPC Director, is also a presidential recess appointment whose appointment is being challenged in a federal court action.  The Restoring the Constitutional Balance of Power Act  also blocks the CFPB's next transfer of funds from the Federal Reserve to carry out any actions that require the approval of a CFPB Director. The funding is automatically restored when the Senate confirms a CFPB Director.
Noting that the  agencies have been operating under a ruse for more than a year, Senator Johanns said that any decisions or regulations made by the people who have no right to be there are invalid. The legislation forces them to stop functioning as if they legitimately hold office and recognize the reality that the President overstepped his constitutional authority, the Senator emphasized. The D.C. Circuit Court of Appeals ruled that President Obama violated the Constitution when he made the  appointments to NLRB without confirmation by the Senate. According to the Senators, the President took the same unconstitutional actions with Richard Cordray, who they maintain has been illegitimately serving as CFPB Director under the same circumstances.

Draft Legislation Moves Germany towards Fee-Based Investment Advice, Creating More Transparency for Investors


The German Government drafted legislation that would move Germany to a system of fee-based investment advice. The Promoting and Regulating Fee-Based Advice on Financial Instruments Act represents an additional building block in the new regulatory framework for financial markets and strengthens the rights of investors. Past experience has shown that providing investment advice on a commission basis can create the wrong incentives. Investors were often given poor advice in the past, with the risks of certain financial products being concealed. The legislation promotes investment advice that is independent and based exclusively on fees. Fee-based investment advisers are not allowed to take commission from the companies or third parties whose products they sell. 
The legislation is based on a 2011 European Commission proposal for amending the Markets in Financial Instruments Directive. The proposal pursues a similar approach regarding fee-based investment advice, which it terms “independent advice”.
With this draft legislation, Germany is taking a lead in Europe in terms of the regulation of fee-based investment advice. The professional designations “fee-based investment adviser” and “fee-based financial investment adviser” will be introduced into Germany’s Securities Trading Act and Trade Regulation Code respectively. This will make it clear to consumers whether investment advisers are being remunerated through commission from product providers or purely through client fees. Consumers can then decide for themselves which kind of investment advice they want to use. Investors will be able to obtain information about fee-based advisers from a publicly accessible register on the website of the Federal Financial Supervisory Authority. Securities professionals wishing to use the designation “fee-based financial investment adviser” will also be required to have a listing in the central registers maintained by the chambers of industry and commerce. 
Further, the legislation would place additional requirements on these advisers, who represent an alternative to the commission-based investment advice which has been predominant until now. In future, fee-based investment advisers will have to have a sufficient knowledge of the market when advising clients. Their services must also be paid for exclusively through client fees. For providers of investment services, commission-based and fee-based investment advice must be separate within the company’s organization.

D.C. Circuit Rules Reporter Had No Access to Report of Independent Consultant Prepared Pursuant to Consent Decree in SEC Enforcement Action

A federal appeals court panel ruled that the report of an independent consultant on a company’s internal policies and past transactions prepared pursuant to a consent decree in an SEC enforcement action was not a judicial record to which a reporter had a right of access. The report of the independent consultant was not a judicial record subject to the right of access because the district court made no decisions about it or otherwise relied on the report. Similarly, documents created by independent consultants are not government documents, reasoned the DC Circuit panel, nor do they memorialize an official matter of legal significance. SEC v. American International Group, CA D of C, Feb. 1, 2013. 

Indeed, the independent consultant had no relationship with the court. The court did not select or supervise the consultant and had no authority to extend the consultant’s tenure or modify his authority. The consent decree gave the independent consultant no powers unique to individuals possessing judicial authority, nor did it require the consultant to file his reports with the court.  In fact, the consent decree did not by its terms directly require anything from the independent consultant; it simply specified the work AIG would engage the independent consultant to perform.

The consent decree was silent on the question of disclosure, but the parties subsequently filed a joint motion to clarify that the reports were to be confidential. The district court agreed, ordering that the reports could be disseminated only to those persons permitted by the court for good cause shown. Since then, the district court has found good cause twice. First, it permitted disclosure to the Office of Thrift Supervision at the request of both parties, and second, it permitted disclosure to the House of Representatives Committee on Oversight and Government Reform at the request of the SEC. The appeals court rejected the argument that the report became a public document when it was provided to the government. Such a transfer of possession, said the panel, is not itself sufficient to render the report a public record.

Saturday, February 02, 2013

Senate Legislation Would Block New Funds to CFPB Pending Confirmation of Director

In the wake of a DC Circuit opinion striking down the presidential recess appointments to NLRB members Senators Mike Johanns (R-Neb.), Lamar Alexander (R-Tenn.) and John Cornyn (R-Texas) introduced legislation prohibiting the NLRB and the  Consumer Financial Protection Bureau (CFPB) from enforcing or implementing decisions and regulations without a constitutionally confirmed board or director. Richard Cordrey, CFPC Director, is also a presidential recess appointment whose appointment is being challenged in a federal court action.  The Restoring the Constitutional Balance of Power Act  also blocks the CFPB's next transfer of funds from the Federal Reserve to carry out any actions that require the approval of a CFPB Director. The funding is automatically restored when the Senate confirms a CFPB Director.
Noting that the  agencies have been operating under a ruse for more than a year, Senator Johanns said that any decisions or regulations made by the people who have no right to be there are invalid. The legislation forces them to stop functioning as if they legitimately hold office and recognize the reality that the President overstepped his constitutional authority, the Senator emphasized. The D.C. Circuit Court of Appeals ruled that President Obama violated the Constitution when he made the  appointments to NLRB without confirmation by the Senate. According to the Senators, the President took the same unconstitutional actions with Richard Cordray, who they maintain has been illegitimately serving as CFPB Director under the same circumstances.

Draft Legislation Moves Germany towards Fee-Based Investment Advice, Creating More Transparency for Investors


The German Government drafted legislation that would move Germany to a system of fee-based investment advice. The Promoting and Regulating Fee-Based Advice on Financial Instruments Act represents an additional building block in the new regulatory framework for financial markets and strengthens the rights of investors. Past experience has shown that providing investment advice on a commission basis can create the wrong incentives. Investors were often given poor advice in the past, with the risks of certain financial products being concealed. The legislation promotes investment advice that is independent and based exclusively on fees. Fee-based investment advisers are not allowed to take commission from the companies or third parties whose products they sell. 
The legislation is based on a 2011 European Commission proposal for amending the Markets in Financial Instruments Directive. The proposal pursues a similar approach regarding fee-based investment advice, which it terms “independent advice”.
With this draft legislation, Germany is taking a lead in Europe in terms of the regulation of fee-based investment advice. The professional designations “fee-based investment adviser” and “fee-based financial investment adviser” will be introduced into Germany’s Securities Trading Act and Trade Regulation Code respectively. This will make it clear to consumers whether investment advisers are being remunerated through commission from product providers or purely through client fees. Consumers can then decide for themselves which kind of investment advice they want to use. Investors will be able to obtain information about fee-based advisers from a publicly accessible register on the website of the Federal Financial Supervisory Authority. Securities professionals wishing to use the designation “fee-based financial investment adviser” will also be required to have a listing in the central registers maintained by the chambers of industry and commerce. 
Further, the legislation would place additional requirements on these advisers, who represent an alternative to the commission-based investment advice which has been predominant until now. In future, fee-based investment advisers will have to have a sufficient knowledge of the market when advising clients. Their services must also be paid for exclusively through client fees. For providers of investment services, commission-based and fee-based investment advice must be separate within the company’s organization.