Wednesday, December 25, 2013

E.U. Parliament and Council Reach Deal on Legislative Package Criminalizing Insider Trading and Market Manipulation

The European Parliament and the E.U. Council have reached agreement on legislation to provide criminal sanctions for insider dealing and market abuse. There will be a common set of criminal sanctions including fines and imprisonment of four years for insider dealing and market manipulation; and two years for unlawful disclosure of inside information. The legislation, which was proposed by the European Commission, would also prohibit the manipulation of benchmarks, including LIBOR and EURIBOR, and make such manipulation a criminal offense The legislation would provide common EU definitions of market abuse offenses such as insider dealing, unlawful disclosure of information and market manipulation. The political agreement is due to be confirmed by the European Parliament in plenary, expected in January 2014.

The draft Directive requires Member States to take the necessary measures to ensure that the criminal offenses of insider dealing and market manipulation are subject to criminal sanctions. Member States will also be required to impose criminal sanctions for inciting, aiding and abetting market abuse, as well as for attempts to commit such offenses. The Directive on criminal sanctions complements a separate and new Regulation on Market Abuse.

The Commission noted that as a result of this legislation Member States will have to establish jurisdiction for these offenses if they occur in their country or the offender is a national. They will also have to ensure that judicial and law enforcement authorities dealing with these highly complex cases are well trained.

The Market Abuse Regulation would adapt EU regulation to the new market reality by extending its scope to financial instruments traded on new platforms and over-the-counter, currently not covered by E.U. legislation. The measure would clarify that market abuse occurring across both commodity and related derivative markets is prohibited, and reinforce cooperation between financial and commodity regulators. The Regulation includes a number of measures to ensure that regulators have access to the information they need to detect and sanction market abuse. Since the sanctions currently available to regulators often lack a deterrent effect, the measure introduces tougher and greater harmonization of sanctions, including possible criminal sanctions which are the subject of a separate but complementary Directive.

Commissioner for the internal Market Michel Barnier said that offenders found guilty of market abuse will finally face jail across the European Union. Together with the  Market Abuse Regulation, the EU has significantly strengthened the powers of Member States to detect and severely punish  insider dealing and market manipulation. In particular, continued the Commissioner, those who manipulate benchmarks such as Euribor will in future face large fines or jail.

Investors who trade on insider information and manipulate markets by spreading false or misleading information can currently avoid sanctions by taking advantage of differences in law between the E.U. Member States. Some countries’ authorities lack effective sanctioning powers while in others criminal sanctions are not available for certain insider dealing and market manipulation offenses.

Insider dealing occurs when a person who has price-sensitive inside information trades in related financial instruments. Market manipulation takes place when a person artificially manipulates the prices of financial instruments through practices such as the spreading of false or misleading information and conducting trades in related instruments to profit from this. Together these practices are known as market abuse.

Benchmarks. Many financial instruments are priced by reference to benchmarks. While it may be difficult or impossible for a competent authority to prove that manipulation of a benchmark had an effect on the price of related financial instruments, any actual or attempted manipulation of important benchmarks can  have a serious impact on market confidence and could result in significant losses to investors or distort the real economy.

The Commission thus feels that it is essential to prohibit manipulation of benchmarks unequivocally, and to clarify that competent authorities could impose administrative sanctions for the offense of market manipulation in these cases, without the need to prove or demonstrate incidental issues such as price effects. It is also essential that all necessary steps be taken to prevent such manipulation and to enable and facilitate the work of competent authorities in imposing sanctions. A stringent legal framework will act as a credible deterrent to such behavior, thereby protecting investors and restoring market confidence. These regulatory steps should include criminal sanctions.

Rapporteur. MEP Arlene McCarthy (U.K. Labor), the rapporteur for the legislation, noted earlier that the LIBOR (London Interbank Offered Rate) scandal was an illustration of greed and market manipulation of the worst kind: manipulation of the most crucial interest rate in global finance, which underpins around USD 350 trillion in derivatives and USD 10 trillion in loans. Regulators in the E.U. and London were caught unawares, she noted, because the existing E.U. market abuse regulations did not cover abuse of non-financial instruments and benchmarks. As a result, the imposition of large fines and the initial prosecution of the LIBOR scandal were carried out by the Commodity Futures Trading Commission, with individual traders being called to prosecution in the U.S. by the Department of Justice.

MEP McCarthy said that the litmus test of the  new Market Abuse Regulation will be whether the E.U. is able to use it to capture potential or emerging abuses and whether they are tough enough to be a deterrent and to sanction abusive practices. Justice in the E.U. would not be served if the E.U. had to extradite those who commit abuses to the U.S. where they would face tougher sanctions and longer jail sentences.

Thus, the legislation not only would close the LIBOR loophole, but also would extend the scope of market abuse rules beyond financial instruments to benchmarks and indices. This is particularly relevant and important, said the MEP, amid press rumors and speculation of manipulation in energy markets. as well as potential manipulation in foreign exchange markets.

The new rules would provide regulators with a range of tough tools, including more severe sanctions and penalties, to monitor, detect and prosecute market abuse.

ESMA Proposes Rules for Imposing Fines on Derivatives Trade Repositories under EMIR

The European Securities and Markets Authority (ESMA).has proposed procedural rules allowing it to fine derivatives trade repositories under its jurisdiction pursuant to the European Markets Infrastucture Regulation (EMIR), which gives ESMA direct supervision of trade repositories.   ESMA must assess and examine the applications of trade repositories for registration and, once the registration is granted, carry out their on-going supervision.

When the conditions in EMIR are fulfilled, ESMA may also recognize trade repositories authorized and subject to effective supervision in the U.S. or other non-E.U. third countries which have been recognized by the European  Commission as having an equivalent and enforceable regulatory  framework and which  have entered into an international agreement with the E.U.,  as well as  into cooperation arrangements.

Pursuant to Article 65 of EMIR, when ESMA finds that a trade repository  has  intentionally or negligently  committed one of the infringements listed in Annex I of EMIR, it must impose a fine in accordance with the relevant provisions of Article 65.  The Commission must approve the procedural rules proposed by ESMA for imposing such a fine.

ESMA proposes that a person subject to investigation would have the  right to be heard at different stages of the procedure.  One of the stages at which the person subject to investigation has the right to be heard is during and after the completion of the investigation by the investigating officer.  After the completion of the investigation, the investigating officer has to produce a statement of findings setting out the facts and the reasons for which they are liable to constitute one or more of the infringements listed in the Annex I of EMIR, including any aggravating or mitigating factors of these infringements.

The person subject to investigation must be given the right to comment on the
statement of findings. In its written submissions, the person subject to investigation should be allowed to comment on the facts set out in the statement of findings, including to set out all the facts known to it which are relevant to its defense.

ESMA considers that another stage where the right to be heard should be guaranteed is where the complete file of the investigation is submitted to the ESMA Board of Supervisors  for deliberation and the adoption of a decision. On the basis of the statement of findings and the written submissions and, if relevant, the minutes of the submissions made at an oral hearing, ESMA must decide whether to close the case or  impose a fine or a periodic penalty payment relating to a fine on the person subject to investigation.
If ESMA introduces a material change to the statement of findings, it must give the person subject to investigation another opportunity to exercise its rights of defense by way of written submissions. If ESMA adopts a decision imposing a penalty on the person subject to investigation, it must notify the person of that decision. In the case of a fine, this notification must be done immediately.

 Under the proposals, ESMA’s power to impose fines on trade repositories would be subject to a five-year limitations period.. The limitations period for imposition of penalties would begin to run on the day following that on which the infringement is committed. 

Corporate Secretaries Urge SEC to be More Flexible in Implementing Dodd-Frank Pay Ratio Provision

The Society of Corporate Secretaries and Governance Professionals urged the SEC to make more flexible the proposed regulations implementing the pay ratio provisions of the Dodd-Frank Act. While the Society fully recognizes that the SEC must adopt regulations implementing Section 953(b) of the Dodd-Frank Act, the group believes that the regulations will add significant costs and impose burdens on public companies to provide disclosure that will not provide investors with material information to making investment decisions.

All that said, the Society, accepting the fact that there will be regulations implementing Section 953(b), has a number of suggested changes in the proposal. The Society believes that the information called for by amended Item 402 should be furnished to, rather than filed with, the Commission. Also, the employees covered by the rule should be limited in two respects. First, part-time and seasonal employees should be excluded from the calculation of median total compensation of all employees. Second, only employees of consolidated subsidiaries, rather than subsidiaries generally, should be included in determining such compensation. Importantly, the Society noted that data privacy laws will impact the gathering of data on non-US employees, and the final rule should take this into account.

In addition, the Society urged the SEC to give a company discretion to choose a date, other than the end of its most recent fiscal year, for determining the median employee for the purpose of the pay ratio regulations. At a minimum, a company should not be required to use the end of the most recent fiscal year. Further, a company should be able to choose more than one compensation measure for the purposes of determining the median employee where it has non-US employees for whom US W-2 data does not exist.

The Society also urges the Commission to permit companies to use compensation data from the year prior to the most recently completed fiscal year, both for determination of the median employee and in the calculation of the pay ratio.

The issue of furnishing versus filing the information looms large with the Society. The Commission rejected the idea of furnishing the information based on what the Society believes is an unnecessarily literal reading of Section 953(b) of the Dodd-Frank Act, which directs the Commission to amend Item 402 of Regulation S-K to require disclosure of the pay ratio in any filing of the issuer described in Item 10(a) of Regulation S-K. The Commission concludes that the use of the word ‘filing’ in Section 953(b) is consistent with the disclosure being filed and not furnished and thus proposes that the pay ratio disclosure would be considered filed for purposes of the Securities Act and Exchange Act and, accordingly, would be subject to potential liabilities under such Acts.

The Society urges the SEC not to give such disproportionate weight to the use of the word filing in Section 953(b). Filing described in Item 10(a) of Regulation S-K include, without limitation, registration statements under the Securities Act and Exchange Act, annual and other reports under Sections 13 and 15(d) of the Exchange Act, and proxy and information statements under Section 14 of the Exchange Act. Some of these filings include disclosures that are considered furnished and not filed. Therefore, reasoned the Society, the legislative mandate to disclose the pay ratio in any filing described in Item 10(a) of Regulation S-K does not mean that such disclosure must necessarily be “filed.” Section 953(b) of the Dodd-Frank Act only prescribes the type of documents in which pay ratio disclosure should appear and does not dictate whether such disclosure should be furnished or filed.

The Society disagrees with the Commission’s apparent belief that the flexibility afforded by the proposed rules supports treating pay ratio disclosure as filed because the flexibility and use of estimates could reduce some of the difficulties of compiling the required information. Indeed, the Society believes that  the opposite is true, that the flexibility and use of estimates makes filed status inappropriate due to the imprecision of the amounts involved.

Another area where the Society believes that the Commission has adopted an unnecessarily literal approach is its view that “all employees” includes part-time and seasonal employees. The statutory provision should not be read so literally that it includes any employee, regardless of the nature of his or her employment.

Employees. Section 953(b) is silent on the definition of “employees,” and there is no legislative history to support that it was intended to have such an expansive application. Including part-time and seasonal employees will generate higher costs and other compliance burdens and will lead to longer and more complex proxy statements. The Society also argued that including part-time and seasonal employees in the ratio would distort the ratio for companies in industries that rely heavily on seasonal employees during high periods of demand, particularly if the companies are not permitted to annualize the salary data. The same is true for other industries that rely heavily on part-time employees. 

Sunday, December 22, 2013

E.U. Parliament and Member States Reach Deal on Legislation to Reform Audit Reports and Mandate Audit Firm Rotation

In a major step, the European Parliament and the E.U. Member States have reached agreement on legislation to reform the audit report on company financial statements and require the mandatory rotation of audit firms. In order to promote competition, the legislation also would prohibit restrictive Big Four only third party clauses imposed on companies. A lack of choice for audit clients resulting from high concentration levels, in essence an oligopoly, is what the legislation aims to correct. Audit quality derives from independence, professional skepticism and technical competence. The European Commission believes that all of these elements will be enhanced by the proposed reforms and consequently, audit quality as a whole will be improved.

Although less ambitious than initially proposed by the Commission, stated Commissioner for the Internal Market Michel Barnier, landmark measures to strengthen the independence of auditors have been endorsed in the legislative agreement, particularly in the auditing of financial institutions and listed companies. This will ensure that auditors will be key contributors to economic and financial stability.

Mandatory rotation. Audit firms would be required to rotate after an engagement period of 10 years. The ten year period could be extended by up to 10 additional years if tenders are carried out, and by up to 14 additional years in case of joint audit under which the company being audited appoints more than one audit firm to carry out its audit. A calibrated transitional period taking into account the duration of the audit engagement is foreseen to avoid a cliff effect following the entry into force of the new rules.

Mandatory auditor rotation is based on the rationale that a long professional relationship undermines auditor independence and negatively impacts on auditor professional skepticism. The Commission rejected the idea of simply rotating the key audit partner as insufficient because the main focus would still be client retention. A new partner would be under pressure to retain a long standing client of the firm, reasoned the Commission, and it would be unlikely that he or she would criticize the work of the previous audit partner. During the comment period, the Big Four audit firms opposed mandatory audit firm rotation and endorsed the current market-driven selection of outside auditors.

Audit report. In order to reduce the expectation gap between what is expected from auditors and what they are bound to deliver, the legislation would require auditors to produce more detailed and informative audit reports, with a required focus on relevant information to investors. Closer cooperation between the auditor, the audit committee and supervisors will also help to clarify and meet the expectations of stakeholders.

Non-audit services. Audit firms will be strictly prohibited from providing non-audit services to their audit clients, including stringent limits on tax advice and services linked to the financial and investment strategy of the audit client. This aims to limit risk of conflicts of interest, when auditors are involved in decisions impacting the management of a company. This is designed to substantially limit the self-review risks for auditors. To reduce the risks of conflicts of interest, the new rules would introduce a cap of 70 percent on the fees generated for non-audit services others than those prohibited based on a three-year average at the group level.

Oversight. Strict transparency requirements would be introduced for auditors with stronger reporting obligations vis-à-vis supervisors. The work of auditors would be closely supervised by audit committees, whose competences are strengthened by the legislation. In addition, in a very novel and innovative change, the legislative package introduces the possibility for 5 percent of the shareholders of the company to initiate actions to dismiss the auditors. A set of administrative sanctions that can be applied by the competent authorities is also foreseen for breaches of the new rules.

Cross-border. The legislation would also provide a level playing field for auditors at the E.U. level through enhanced cross-border mobility and the harmonization of International Standards on Auditing (ISAs). Cooperation between national supervisors will be enhanced at the E.U. level, with a specific role devoted to the European Markets and Securities Authority (ESMA) with regard to international cooperation on audit oversight.

Senators Grassley and Reed ask FINRA to respond on expungement of investor complaints against brokers

In an effort to protect investors and the integrity of FINRA’s BrokerCheck program, Senators Charles Grassley (R-IA) and Jack Reed (D-RI) urged FINRA to clarify and enhance standards for the expungement of investor complaints against brokers. The Senators are concerned about a recent study that revealed that a disturbing frequency of investor complaints being expunged or removed from publicly available broker records maintained by FINRA. Senator Grassley is the Ranking Member on the Judiciary Committee and Senator Reed is a key member of the Banking Committee.

In a bi-partisan letter to FINRA Chair Richard Ketchum, the Senators asked FINRA to provide, by January 6, 2014, the number of instances in which FINRA has questioned or challenged the provision of expungement relief and a detailed description of the circumstances each time. More broadly, the Senators ask FINRA to provide them with draft legislative language that would be necessary to provide FINRA with the authority to ensure that expungement relief is provided only when it has no meaningful investor protection or regulatory value, if FINRA does not believe that such authority already exists.

The Senators share FINRA’s view that expungement is an extraordinary remedy that should be granted only under appropriate circumstances and should be allowed only when it has no meaningful investor protection or regulatory value. However, the Senators also believe that meaningful investor protection includes the disclosure of whether a customer dispute was  settled. This is not just for the sake of transparency, but also to help prospective investors make informed decisions             about which firms or individual brokers to do business with.

Financial Industry Representatives Detail Impact of Default on Markets before Senate Panel

Financial industry representatives related this year  to the Senate Banking Committee the impact that default would have on the financial markets. With regard to Treasury securities, SIFMA President, and former U.S. Representative (D-TX), Ken Bentsen testified that Treasury’s  intention not to make a payment timely remains the key variable under all the scenarios reviewed. Given the limitations of the transfer mechanism for Treasury securities, he noted, failure to provide sufficient notification for a payment failure would prevent the security from being further transferred. Holders of such a security may have limited opportunity to sell it, finance it through repo or post it as collateral.

As a result of a late notification, a Treasury security on which a payment is not made may not be further transferable. Although SIFMA assumes that the missed payments will eventually be made, while the payment remains unpaid the holder of the security that expected its payment may not be able to sell the security or finance it in the repo market. Similarly, collateral and margin requirements at clearing houses and central counterparties may no longer be able to be satisfied with these securities.

Further, it is entirely possible that any escrow, collateral or margin arrangement involving such securities could result in them being deemed non-eligible and subject to replacement. Essentially, explained the SIFMA official, the holder would have a receivable from the Treasury that could not be further transferred and, overall some frictional decrease in liquidity in the market could be expected.

The impact could be widespread, he continued. Counterparties might begin to question whether other counterparties would be able to replace ineligible collateral. Disruptions in the Treasury repo market would further impact price changes on Treasury securities.

Treasuries are the world’s safest asset and the most widely used collateral for both risk mitigation and financing. Shrinkage in the financing market would further pressure rates as haircuts on Treasuries would increase, thus reducing financing capability and disrupting the collateral market because of margin calls throughout the financial system that would reflect the overall repricing of Treasury collateral.

Once Treasury fails to make a timely payment, observed Mr. Bentsen, markets will have to wait each day for Treasury’s indications as to its intentions for payments due on the following days. If this were to continue for any length of time, he emphasized, market participants would need guidance on missed payments as well as future payments on additional securities. In addition, coupon payments that are not paid will ultimately be paid to the holder of record of the security on the day the payment should have been made. Uncertainty on that payment would continue until payment is finally made.

Also, securities that are coming due in the short-term would be less attractive to hold and may become harder to finance as doubts about the payment of interest and principal when due would be more prevalent. Even if the debt ceiling were raised at the last minute, experience from the 2011 event suggests that securities that may be the subject of a default in the near future will trade at a premium and will be more expensive to finance

Municipal securities. According to the SIFMA official, there are specific issues with regard to the municipal securities market. A key interaction between municipal securities and Treasury securities involves municipal refunding transactions. A refunding typically occurs when interest rates have fallen since a state or municipality issued long-term bonds, and a borrower is able to achieve interest cost savings by refinancing bonds at the current lower rates.

When a refunding can be achieved before the old, higher-interest bonds can be redeemed early, the borrower invests the proceeds of the new, lower-interest bonds in Treasury securities, and the income earned from these investments is used to pay debt service on and eventually redeem the old bonds. When old, higher-interest bonds are fully backed by an escrow portfolio, they are said to be “defeased” or “escrowed” and treated as triple-A rated.

Mutual fund industry. Paul Schott Stevens, President and CEO of the Investment Company Institute, testified that funds registered under the Investment Company Act hold more than 10 percent of their assets in Treasury and U.S. government securities. Such holdings are pervasive, he noted, with 30 percent of mutual funds holding these securities. Equity funds rely on Treasury securities for cash management and liquidity. Thus, he concluded that the 90 million Americans invested in funds share significantly in the risks associated with a Treasury default.            

Saturday, December 21, 2013

Senate Co-Authors of Volcker Rule say Enforcement Will be Critical

In reflecting on the adoption of the Volcker Rule by the federal financial regulators, Senators Jeff Merkley (D-OR) and Carl Levin (D-MI), co-authors of Section 619 of the Dodd-Frank Act codification of the Volcker Rule said that enforcement and public accountability will be critical going forward. While they are still reviewing the details of the adopted Volcker Rule, the Senators noted that early indications suggest that common sense has prevailed in the face of even the fiercest special interest lobbying campaigns. In the final Volcker Rule, hedging looks tougher, market-making looks simpler, trader compensation remains appropriately structured, and CEOs are required to set the tone at the top.

Section 619 was, among other things, intended to change the culture and practices at the largest financial firms, noted the Senators, and in the final Volcker Rule the financial regulators have taken a serious step forward in mandating critical corporate governance and tone at the top changes.

Further, the Volcker Rule firewall, as embodied in the Merkley-Levin Amendment to Dodd-Frank, remains intact to bars lending banks and their affiliates and subsidiaries from engaging in the speculative, conflict-ridden activities of making bets on the stock, bond, derivatives, and other markets and limits those activities at systemically important nonbank financial institutions. The firewall erected by the regulators acting pursuant  to Section 619 allows for customer-oriented services, such as underwriting and market-making to facilitate capital formation for clients, risk-mitigating hedging activities to permit safe and sound operations, and fund management services for customers.

Wednesday, December 11, 2013

Senator Levin Urges SEC to Toughen Proposed Monitoring of Reg. D Post Ending of General Solicitation Ban

Senator Carl Levin (D-MI) said that the SEC’s proposal to monitor concerns over permitting issuers to engage in general solicitation under Rule 506 pursuant to the JOBS Act do not go far enough to protect investors from fraudulent offerings on what the Senator called ``the soon-to-be "Wild West" that now exists under the final Rule 506. In a letter to the SEC, he urged the Commission to further enhance the proposal to ensure that investors in Rule 506(c) offerings are provided with full disclosure information and that such investors are actually accredited investors as required by Congress.
Currently, a Form D is not required to be filed until l5 days after a Rule 506(c) offering has commenced. The Commission's proposes to require filing an Advance Form D before a general solicitation offering commences. Senator Levin said that, rather than allowing potential issuers to file an Advance Form D that contains limited information, issuers should be required to file a full and complete Form D at least 15 days before a general solicitation begins.

Senator Levin rejected the idea advanced by Rep. Patrick McHenry (R-NC) in a letter to SEC Chair Mary Jo White that a 15-day pre-solicitation filing requirement may violate the JOBS Act. An examination of the statute and accompanying legislative history clearly rebuts such a suggestion, he said. That a 15-day pre-solicitation filing requirement does not violate the JOBS Act is clear from the legislative history of the JOBS Act, he maintained, noting that pre-filing requirements are common for offerings, and nothing in the JOBS Act or the legislative history suggests that this legislation limits the Commission's authority to amend filing requirements as it sees fit for Rule 506 offerings.

In fact, the Senator asked the SEC to consider whether 15 days is an adequate amount of time for its staff and state securities regulators to analyze filings for compliance and that banned bad actors are not participating in new issuances. Whatever  time period is adopted, he is concerned that the Commission staff will not review each Advance Form D promptly after it has been filed. If the Commission fails to review Advance Form D filings or take action against those found to be deficient, he warned, the beneficial changes put in place by the proposal will be largely lost. In addition to considering whether 15 days is an appropriate amount of time for pre­filing, he said that the SEC should ensure that all Advance Form D filings are reviewed by staff prior to the commencement of solicitation and that full Form D filings are reviewed promptly after being filed.

Verification. He also urged the SEC to significantly strengthen the verification requirements to ensure that investors in Rule 506(c) offerings are in fact accredited investors. The legislative history of the JOBS Act makes clear that Congress closely considered and intended for the lifting of the general solicitation ban to be coupled with the requirement that only accredited investors participate in these offerings. The safe harbor standards for the verification of investor income and net worth that the Commission has adopted unfortunately are far too wide and should be strengthened by requiring additional documentation and verification.

The safe harbors should be exclusive, he reasoned, because if they are not exclusive, then the Commission leaves wide open the opportunity for issuers to adopt investor verification regimes that meet the Commission's very low "reasonable steps" and "reasonable belief'' standards for verification and allow considerable leeway for non-accredited investors to be sold unregistered securities.

Thus, the SEC is undermining the fundamental principle of the JOBS Act, which is that only accredited investors can participate in Regulation D unregistered offerings. In addition, by relying on a "facts and circumstances" analysis, the Commission faces a difficult enforcement environment in which each fraudulent case that occurs under the general solicitation exemption will require the Commission to litigate the "facts and circumstances".

Also, the Senator said that the Commission should require that documentation used by or on behalf of the issuer to verify an investor's qualification as an accredited investor be maintained by the verifying party for a reasonable time and be made available to the Commission for inspection on request.

Canadian Supreme Court Rules Limitations Period in Securities Act Triggered by Settlement of Enforcement Action not Underlying Misconduct

In a strong statement of judicial deference to the expertise of an administrative agency, the Canadian Supreme Court ruled that the six-year statute of limitations in the British Columbia Securities Act was triggered by the settlement of an Ontario Securities Commission enforcement action and not by the misconduct underlying the action. While both the actor and the British Columbia Securities Commission proposed reasonable interpretations of the Act, the Court employed a  reasonableness review under which judicial deference is due to any reasonable interpretation adopted by an administrative agency, even if other reasonable interpretations may exist.  Because the Commission’s interpretation has not been shown to be an unreasonable one, ruled the Court, there is no basis to interfere on judicial review. (McLean v. British Columbia Securities Commission, Supreme Court of Canada, No. 34593, Dec. 5, 2013)

On September 8, 2008, the securities professional entered into a settlement agreement with the Ontario Securities Commission regarding misconduct that occurred in Ontario, in 2001 or earlier.  The Ontario Securities Commission issued an order barring her from trading in securities for five years and banning her from acting as an officer or director of certain entities registered in Ontario for 10 years.  On January 14, 2010, the Executive Director of the British Columbia Securities Commission notified the actor that he was applying to the Commission for a public interest order against her based on the BC Securities Act. The Court of Appeal applied a correctness standard of review and upheld the Commission’s implied decision that the event for the purposes of the limitations  period that gave rise to the proceedings in British Columbia was the settlement agreement in Ontario

While the appeals court reached the right conclusion, the Supreme Court said that the court erred by applying a correctness standard of review.  The reasonableness standard with proper judicial deference was the right standard of review here, said the Supreme Court, which added that it is presumed that courts will defer to an administrative agency interpreting its own statute or statutes closely connected to its function.  Here, that presumption was not rebutted.

Nor does the question fall within any exceptional category that warrants a correctness standard.  Although limitation periods generally are of central importance to the fair administration of justice, said the Court, the issue here was statutory interpretation in a particular context within the Commission’s specialized area of expertise.  The possibility that other provincial securities commissions may arrive at different interpretations of similar statutory limitation periods is a function of the Constitution’s federalist structure and does not provide a basis for a correctness review. 

Finally, and most significantly, the modern approach to judicial review recognizes that courts may not be as qualified as an administrative tribunal to interpret that tribunal’s home statute.  In particular, the resolution of unclear language in a home statute is usually best left to the administrative tribunal because the tribunal is presumed to be in the best position to weigh the policy considerations often involved in choosing between multiple reasonable interpretations of such language.

ESMA Chair Goes Beyond Maystadt Report in Espousing E.U. Involvement in IFRS Standard Setting

Keying on the recent report of Philippe Maystadt to the European Commission  recommending that EFRAG be transformed to get the E.U. more involved in IFRS standard setting, the European Securities and Market Authority Chair Steven  Maijoor said that more must be done to improve he governance of the IFRS oversight body.  The  first thing would be to ensure that all E.U. Member States are represented, noted the Chair, and the second thing would be to ensure the proper interaction with existing European authorities playing an important role in the area of financial reporting. In remarks at an Ernst & Young seminar on financial reporting, he said that the third principle is to ensure independence from private stakeholders’ interests which has been identified as a significant weakness of the current system. Of course, assured the ESMA Chair, this independence does not preclude in any way extensive consultations of market participants as part of the regulatory process.

European Commissioner for the Internal Market Michel Barnier asked Philippe Maystadt to compile a report on the governance framework around the E.U. endorsement mechanism for accounting standards. The Maystadt Report explored various options in relation to the body which should provide endorsement advice to the Commission, and recommended the use of the current EFRAG structure with some changes in terms of governance in order to transform it from a fully private body to a structure with
more prominent public interest elements.

IASB. The new structure would fulfill EFRAG’s current technical role, but would also be able to carry out a strategic analysis of the economic impact of the accounting standards under scrutiny, relying on adequate conceptual and technical means.  The new structure would also allow EFRAG to provide the IASB and the Commission with analyses on both technical and economic considerations

The ESMA Chair believes, however, that it is important to ensure that its governance should be subject to more significant changes which should follow the three principles for enhanced E.U. involvement. He urged the Commission to ensure that these principles will be taken into consideration when putting forward its proposals.

He also emphasized that ESMA, in line with its mandate regarding financial reporting, must play an important role in financial reporting enforcement and ensure that enforceability matters are considered as part of the standard setting process. ESMA will work with the Commission to ascertain how the proposed new framework can fulfill that mandate. 

With about 7000 E.U. listed companies currently using IFRSs, noted Chairman Maijoor, the E.U.’s interest needs to be reflected within the governance model of the entire IFRS Foundation, including the IASB and the Monitoring Board. Concerns raised by the European Union should be heard and dealt with, he noted, which can only be achieved with a credible and robust IFRS endorsement mechanism. This is also behind the sentiment of the European Commission in issuing the Maystadt Report offering suggestions on how the E.U. could have a more active role in setting international accounting standards.

IASB Oversight Body Takes Issue with Maystadt Report on How to Increase E.U. Involvement in IFRS Standard Setting

The oversight body of the IASB said that recommendations by the Maystadt Report to give the E.U. more say in IFRs standard setting could further lengthen what are already very lengthy procedures and incorrectly stated that the IASB is overly influenced by US GAAP. The central theme of the report is to transform the European Financial Reporting Advisory Group (EFRAG) into a vehicle for enhancing E.U. influence on international accounting standard setting. For example, the report wants EFRAG to request the IASB to have longer comment periods on consultative documents, noted the IFRS Foundation, when the IASB already has an extensive due process, which was revised earlier this year following a consultation with all global constituents. 

In its statement, the IFRS Foundation said that their global constituents can meet the IASB’s comment deadlines and would not wish to see them being extended to meet a request from Europe. Further, it would considerably hinder the IASB’s ability to operate efficiently if it agreed to an EFRAG request for even longer comment periods. The IASB is acutely conscious of the fact that it takes years to develop a new IFRS and, noted the Foundation, is looking to reduce the time taken, rather than providing further extensions and thereby slowing down the process even more.

Influence of US GAAP. The IFRS Foundation disputed the idea that U.S. influence is overstated. The report’s reference to the IASB continuing to acknowledge the major influence of FASB positions is not an accurate characterization. During the IFRS-GAAP convergence projects with FASB, the IASB maintained its independent voice, even when working with FASB, on issues on which it has taken a different view that was based on the merits of the issue at stake. This is demonstrated by the fact that there remain differences between IFRS and US GAAP, for example in the treatments relating to the offsetting of financial instruments and the definition of control that is the basis for consolidation.

Further, the worldwide spread of IFRSs made it more appropriate for the IASB to adopt a new strategy and to move to a multilateral engagement with FASB and other national standard-setters and regional bodies. The wording in the Maystadt Report does not acknowledge this fact. The shift to a multilateral approach is most notably demonstrated by the establishment of the Accounting Standards Advisory Forum, on which 3 of the 12 members come from the EU (plus one at large member , the UK), and 3 from the Americas (representing the US, Canada and the Group of Latin American Standard-Setters, GLASS).

Financial stability. The IFRS Foundation also rejected the idea of introducing financial stability and economic development standards into IFRS. Accounting standards should not be “instrumentalized” with a view to hiding or twisting the objective representation of the situation and the performance of businesses. While the IFRS Foundation supports the goals of financial stability and economic growth, IFRS can best make a contribution to both by providing transparency to the capital markets. The idea is based on an ongoing misunderstanding as to the purpose of general financial reporting, and about its limitations, and how it interacts with financial stability.

FCAG. The report of the Financial Crisis Advisory Group set out the real situation and how both accounting standard-setters and prudential regulators serve the public interest in accordance with their respective missions. The FCAG emphasized that financial reporting, by providing only a snapshot in time of the economic situation and performance, cannot provide perfect insight into the effects of macroeconomic developments. However, what it does do is provide as unbiased and relevant information as possible about the economic performance and condition of businesses in a way that provides confidence to investors and other capital market participants in the transparency and integrity of that information.

Sunday, December 08, 2013

ESMA Hints at Possible Enforcement Action over Credit Rating Agency Sovereign Ratings

The European Securities and Markets Authority (ESMA), the direct  regulator of credit rating agencies in the European Union, has identified a number of deficiencies in the processes for producing and issuing sovereign ratings at the three largest rating agencies, Fitch Ratings, Moody’s Investors Service and Standard & Poor’s. The report found need for improvement in the areas of independence and avoidance of conflicts of interests; confidentiality of sovereign rating information; timing of publication of rating actions; and resources allocated to sovereign ratings. ESMA has not yet determined whether any of the findings in the report constitute a breach of the provisions of the CRA Regulation. But ESMA kept open the possibility of further investigations which could lead to enforcement actions.

Saturday, December 07, 2013

Fed Gov. Powell Joins Global Chorus calling for Strong Risk Management at Derivatives Central Counterparties

Joining a growing global consensus for robust risk management at derivatives central counterparties, Federal Reserve Board Governor Jerome Powell said that these central counterparties must hold themselves to the highest standards of risk management, given that they could create a single point of failure for the entire financial system. In remarks at the Clearing House annual meeting, he noted that derivatives central counterparties must manage two distinct yet interrelated risks: liquidity risk and credit risk. Credit risk is the potential for the central counterparty to incur losses after it closes out a defaulter's positions and liquidity risk  is the possibility that a central counterparty will not have sufficient cash on hand to timely meet its payment obligations.

Recently, the German central bank, the Bundesbank, called for enhanced risk management at derivatives central counterparties. Andreas Dombret, the member of the Bundesbank Executive Board with oversight of financial stability, said that the Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR) could turn derivatives central counterparties into “juggernauts” of the international financial system. As such, he advised every central counterparty to implement a robust risk management regime.

The credit and liquidity risks borne by a central counterparty arise from the clearing activities of its members, explained Gov. Powell, and those risks materialize when a clearing member defaults. Most of the financial resources to cover risk exposures will come from members, he noted, and a member's default will require the central counterparty to work with surviving members in the context of prevailing market conditions.

Central counterparties play a critical role in ensuring a robust risk management regime that fully takes account of this interplay among markets, institutions, and infrastructure. Gov. Powell emphasized that regulators, clearing members, and their clients also must be engaged in making sure that central counterparties are safe and effective at managing the risks, interactions, and interdependencies inherent in the clearing process

In his view, there are three key elements to ensuring that central counterparties are effective in mitigating systemic risks: 1) enhancing regulation; 2) strengthening risk management and governance; and 3) promoting the stability of clearing members. 

Enhancing central counterparty regulation. The decision to require central clearing of standardized derivatives as a foundation for reform has raised the stakes for central counterparties, clearing members, regulators, and the general public. At the international level, financial regulators have addressed this challenge by updating, harmonizing, and strengthening the minimum risk management standards applied to financial market infrastructures, including central counterparties.

The primary basis for the regulation of derivatives central counterparties are the European Market Infrastructure Regulation (EMIR) and Title VII of the Dodd-Frank Act. Both laws establish a framework for reporting, regulating, and clearing OTC derivatives transactions. They also call for international coordination on enhanced risk management standards for central counterparties. However, differences of implementation of EMIR and Title VII have emerged. Gov. Powell warned that governments must ensure that such differences do not lead to regulatory arbitrage or weakened standards.

More granularly, in addition to Dodd-Frank and EMIR, the globally-developed Principles for Financial Market Infrastructures have set a higher bar for risk management to strengthen these core market infrastructures and promote financial stability. Recently, the CFTC finalized its adoption of the Principles for the derivatives clearing organizations it regulates.

The Principles require that a central counterparty  develop strategies to cover its losses and continue operating in a time of widespread financial stress. In particular, a central counterparty must maintain financial resources sufficient to cover its current and potential future exposures to each participant fully with a high degree of confidence; and maintain additional resources to cover the failure of the clearing member with the largest exposure under extreme but plausible market conditions.

Governance of Risk Management. Gov. Powell strongly emphasized that managing credit and liquidity risk requires sound and effective governance, an important aspect of which is enhanced transparency. Clearing members bear primary responsibility for understanding the risks associated with participating in a central counterparty, including their potential exposures in the event of a default. This will require the central counterparty  to provide relevant and even firm-specific information to facilitate the members' analysis. Clearing members and their clients, regulators, and the broader public require transparency so that they can assess the adequacy of risk management at the central counterparty and its overall risk profile.

The Principles for Financial Market Infrastructures also have a key role to play in the sound governance of risk management. In this regard, Gov. Powell pointed out that, in order to promote credit risk management, the Principles require a central counterparty to collect variation margin from its members to limit the buildup of current exposures. In addition, they must also calculate and collect initial margin sufficient to cover potential changes in the value of each participant's position between the last collection of variation margin and the final closeout of a participant's position should it default.

Clearing members. Noting the critical role played by clearing members, the Fed official said that a central counterparty ultimately draws its strength and resilience from that of its members. And it is not a one-way street, he added, since strong central counterparties enable clearing members and their clients to significantly reduce their exposure to counterparty credit risk. Effective risk management by both a central counterparty and its clearing members should work in concert.

NY Fed Official Says Financial Stability Part of Central Bank’s Mandate

In one of the most thought-provoking comments of the year, a NY Fed official, citing the penumbra doctrine advanced by Justice William O. Douglas in the Griswold case,  said that financial stability should be part of the Fed’s mandate in addition to price stability and maximizing employment.

Citing Justice Douglas, N.Y. Fed Executive Vice President and General Counsel Thomas Baxter found a third mandate to promote financial stability in a penumbra to the Federal Reserve Act and in express provisions in the Dodd-Frank Act. In remarks at recent E.U. conference, he noted that the legal basis for deriving implied powers from the penumbra of other express powers is best seen in the opinion of Justice Douglas in Griswold v. Connecticut, where he reasoned that the First Amendment has a penumbra where privacy is protected from governmental intrusion, in particular the right of association. 

Similarly, the Federal Reserve Act has a penumbra where the Federal Reserve derives its mandate to ensure financial stability, such that it may achieve the Section 2A dual mandate of price stability and maximum employment.  The key point here is that the Federal Reserve’s financial stability mandate is derived from what lies in the penumbra, reasoned the Fed official, not from any express reference to financial stability in the Federal Reserve Act itself. 

And, financial stability is an open and obvious topic of Title 1 of the Dodd-Frank Act, whose most consequential provisions is Section 165, which empowers the Board of Governors to develop enhanced prudential standards for systemically important financial institutions.  In a provision directly affecting central bank powers, Congress instructs the Federal Reserve to develop prudential standards to prevent or mitigate risks to financial stability  that could arise from the material financial distress or failure, or ongoing activities, of large interconnected financial institutions.

There are other provisions of the Dodd-Frank Act granting new powers to the Federal Reserve with respect to financial stability, noted the NY Fed official. One obvious provision is Section 604, which amends the Bank Holding Company Act to direct the Federal Reserve to consider, when it evaluates an application for approval of a proposed acquisition, merger, or consolidation, whether it would result in greater or more concentrated risks to the stability of the United States banking or financial system.

Monday, December 02, 2013

ESMA Chair Goes Beyond Maystadt Report in Espousing E.U. Involvement in IFRS Standard Setting

Keying on the recent report of Philippe Maystadt to the European Commission  recommending that EFRAG be transformed to get the E.U. more involved in IFRS standard setting, the European Securities and Market Authority Chair Steven  Maijoor said that more must be done to improve he governance of the IFRS oversight body.  The  first thing would be to ensure that all E.U. Member States are represented, noted the Chair, and the second thing would be to ensure the proper interaction with existing European authorities playing an important role in the area of financial reporting. In remarks at an Ernst & Young seminar on financial reporting, he said that the third principle is to ensure independence from private stakeholders’ interests which has been identified as a significant weakness of the current system. Of course, assured the ESMA Chair, this independence does not preclude in any way extensive consultations of market participants as part of the regulatory process.

European Commissioner for the Internal Market Michel Barnier asked Philippe Maystadt to compile a report on the governance framework around the E.U. endorsement mechanism for accounting standards. The Maystadt Report explored various options in relation to the body which should provide endorsement advice to the Commission, and recommended the use of the current EFRAG structure with some changes in terms of governance in order to transform it from a fully private body to a structure with
more prominent public interest elements.

IASB. The new structure would fulfill EFRAG’s current technical role, but would also be able to carry out a strategic analysis of the economic impact of the accounting standards under scrutiny, relying on adequate conceptual and technical means.  The new structure would also allow EFRAG to provide the IASB and the Commission with analyses on both technical and economic considerations

The ESMA Chair believes, however, that it is important to ensure that its governance should be subject to more significant changes which should follow the three principles for enhanced E.U. involvement. He urged the Commission to ensure that these principles will be taken into consideration when putting forward its proposals.

He also emphasized that ESMA, in line with its mandate regarding financial reporting, must play an important role in financial reporting enforcement and ensure that enforceability matters are considered as part of the standard setting process. ESMA will work with the Commission to ascertain how the proposed new framework can fulfill that mandate. With about 7000 E.U. listed companies currently using IFRSs, noted Chairman Maijoor, the E.U.’s interest needs to be reflected within the governance model of the entire IFRS Foundation, including the IASB and the Monitoring Board. Concerns raised by the European Union should be heard and dealt with, he noted, which can only be achieved with a credible and robust IFRS endorsement mechanism. This is also behind the sentiment of the European Commission in issuing the Maystadt Report offering suggestions on how the E.U. could have a more active role in setting international accounting standards.

Sunday, December 01, 2013

Senate Legislation would Deny Tax Deduction to Companies Settling Government Enforcement Actions

In an effort to protect taxpayers, hold corporate wrongdoers accountable, and deter future fraud, Senators Jack Reed (D-RI) and Charles Grassley (R-IA) introduced legislation to rescind tax deductions under the federal tax code for payments made by companies to remedy illegal corporate behavior.  The bipartisan Government Settlement Transparency & Reform Act, S. 1654, would close a loophole that has allowed some corporations to reap tax benefits from payments made at government direction stemming from settling misdeeds. Senator Reed is a senior member of the Banking Committee; and Senator Grassley is the Ranking Member on the Judiciary Committee.
Federal law currently prohibits companies from deducting public fines and penalties from their taxable income, but offending companies may often write off any portion of a settlement that is not paid directly to the government as a penalty or fine for violation of the law.  This allows some companies to lower their tax bill by claiming settlement payments to non-federal entities as tax deductible business expenses.
The Reed-Grassley Act would require the government and the settling party to reach pre-filing agreements on how the settlement payments should be treated for tax purposes.  The legislation clarifies the rules about what settlement payments are punitive and therefore non-deductible; and increases transparency by requiring the government to file a return at the time of settlement to accurately reflect the tax treatment of the amounts  that will be paid by the offending party.

More specifically, S. 1654 would amend Section 162(f) of the federal tax code to deny tax deductions for certain fines, penalties, and other amounts related to a violation or investigation or inquiry into the potential violation of any law. Amounts paid by corporations, which constitute restitution for damage caused by the violation of any law are exempted and remain deductible.  This section requires that nongovernmental entities which exercise self-regulatory powers be treated as government entities for purposes of disallowing deductions under the section. The bill also requires the government o stipulate the tax treatment of the settlement agreement. 

U.K. FRC to Implement Sharman Commission Proposals on Going Concern

In a partial implementation of the Sharman Commission recommendations, the U.K. Financial Reporting Council would require outside auditors of financial statements to consider whether reporting is fair, balanced and understandable, and to consider and report if they are aware of any material matter in connection with the disclosure of principal risks that should be disclosed. The FRC also proposes to remove the current Corporate Governance Code provision requiring listed companies to make a going concern statement. The FRC concluded that the best way to address these issues is to integrate its current guidance on going concern and risk management and internal control, and to make some associated revisions to the Corporate Governance Code. A going concern statement is focused on the narrow meaning of assessing the going concern basis of accounting, reasoned the FRC, and so detracts from the broader integrated assessment and description of solvency and liquidity risks envisaged by Lord Sharman.

The draft sets out the duty of directors to set the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organization, and assessing and managing the principal risks facing the company, including risks to its solvency and liquidity. The board should summarize the process applied in reviewing the effectiveness of the system of risk management and internal control and explain what actions have been taken to remedy any significant failings or weaknesses identified from that review.

n its seminal report on auditors and going concern, the Sharman Commission recommended a process to produce a going concern opinion that envisions a key role for company directors, audit committees and auditors. The panel would also require the going concern assessment process to focus on solvency risks and liquidity risks, as well as identifying risks to the company’s business model or capital adequacy that could threaten its survival. The Sharman Commission wants to move away from a model where the company only highlights going concern risks when there are significant doubts about its survival, to one which integrates the going concern reporting with the directors’ discussion of strategy and principal risks.

A meeting earlier this year of the PCAOB’s Standing Advisory Group revealed a growing consensus in the SAG that going concern must focus beyond the traditional liquidity risk to other risks. This dovetails with the Sharman Panel, which urged the UK oversight authority to ensure that the going concern guidance for directors reflects the right focus on solvency risks, not only on liquidity risks, including identifying risks to the company’s business model or capital adequacy. Similar to the Sharman Panel, SAG members are also concerned about the current binary nature of the going concern report.

The Sharman report was initiated by the Financial Reporting Council, the UK counterpart to the PCAOB. Lord Sharman, Chairman of the Commission, said that, while the work of the panel emanates from the financial crisis, companies in all sectors can do more to improve their management and disclosure of risks relating to going concern, liquidity and solvency. There should also be early identification and attention to economic and financial distress, he noted. Lord Sharman was the Liberal Democrat Spokesperson for Trade and Industry/Business and Regulatory Reform from 2001 to 2010.

SEC Chair White Explains Staff Study of Accredited Investor Definition to Rep. McHenry

In a letter to House oversight committee chairs, SEC Chair Mary Jo White said that the Commission staff has begun a comprehensive review of the accredited investor definition. The review will encompass, among other things, the question of whether net worth and annual income should be used as tests to determine whether a natural person is an accredited investor. As part of that review, SEC staff also plans to consider and independently evaluate alternative criteria for the accredited investor definition suggested by the public and other interested parties. Once the review is completed, said the chair, the SEC will consider whether to change the definition through the notice and comment rulemaking process. As part of that process, pledged the chair, the SEC would engage in a thorough economic analysis of the impacts of various approaches to defining accredited investor.

Chair White’s  letter was in response to an earlier letter from Rep. Scott Garrett (R-N.J.), chair of the House Capital Markets Subcommittee and Rep. Patrick McHenry (R-N.C.), chair of the Oversight and Investigations Subcommittee of the House Financial Services Committee.

Section 413 of the Dodd-Frank Act requires the SEC to undertake a review of the accredited investor definition in its entirety as it relates to natural persons four years after enactment. Chair White expects that the review the staff is undertaking and the feedback received through that process will inform the Commission's consideration of whether or not to change the definition.

The SEC chair responded to a number of specific questions asked by Chairmen Garrett and McHenry. The House oversight chairs contended that permitting sophisticated investors, such as certified public accountants (CPAs) and chartered financial analysts (CFAs) to participate in private investment opportunities would improve information dissemination and analysis surrounding such opportunities. By excluding these highly trained financial professionals from investing in certain offerings, unless they meet wealth or income tests, the chairs wondered if the SEC is placing accredited investors at risk. They also wondered whether the review of investments by trained professionals with vested interests would help reveal problems of an issuer.

Chair White responded that professional certifications, such as a CPA or a CFA, are among the possible supplemental or alternative criteria for qualifying as an accredited investor that SEC staff will consider as part of its review. Such a certification, she acknowledged, may position an individual to be able to analyze more comprehensively a company's financial condition and results of operations. The question of whether those with certain licenses, including CPAs, CFAs, and securities licenses or degrees, should provide an independent basis to qualify as an accredited investor will be part of the staff’s review.

Analysis of the income levels of various licensed professions may help to evaluate the marginal impacts, including the impact on capital formation, of allowing for this type of qualification when compared to the current population of accredited investors. For example, certain licensed individuals may already qualify as accredited investors because of their income or net worth. White also noted that the inclusion of more financially sophisticated investors in the definition of accredited investor should increase the extent of the expert review of issuances.

Responding to a question on liquidity, the SEC chair said that expanding the pool of accredited investors potentially could increase the liquidity available for private market investments, although any change in the pool of accredited investors must consider the qualifications of the investors added to or subtracted from the pool. The Commission staff is considering the degree to which the size and composition of the pool of accredited investors could affect liquidity and issuers' ability to raise capital through private offerings. This consideration will include an analysis of the potential overlaps in the various pools of investors that could exist under various definitions.

For example, if there is significant overlap with the set of individuals who would qualify under an income or net worth test, then including criteria other than income and net worth to determine whether an individual meets the accredited investor standard may not materially change the pool of accredited investors. If, however, including criteria other than income and net worth seems likely to increase the pool, then further analysis could include evaluating possible investment levels by those additional investors, and evaluating potential impacts on capital formation.

Responding to a congressional query on whether reliance on a qualified broker or registered investment adviser should enable ordinary investors to participate in Regulation D Rule 506 offerings, Chair White assured them that question is one of many factors that the staff will consider.
White added that obtaining the advice of a professional adviser may enhance an investor's ability to make an informed investment decision, and therefore strengthen investor protection in Rule 506 offerings. White cautioned, however, that an investor's use of such an adviser may not necessarily measure the investor's understanding of the risks of the investment. As part of its review, the staff may determine that it is feasible to analyze the extent to which investors file claims against professional advisers arising from investments in unregistered offerings. Such an analysis may assist in evaluating the level of protection afforded to investors when relying on professional advisers.

Noting that the Regulation D 506 market raises equity capital in excess of one trillion dollars annually, a level exceeding that of the combined public debt and equity markets, the representatives asked the macro question of whether diminishing the pool of eligible investors could potentially harm U.S. GDP.

Chair White replied that the staff review of the definition of accredited investor will consider the potential economic consequences of using alternative criteria to qualify as an accredited investor. Indeed, understanding these potential economic consequences will be an integral component of the review, and an essential part of the staff’s work during this process.