Friday, February 21, 2014

Senate Legislation Would Replace Dodd-Frank Title II with New Chapter in Bankruptcy Code

Senators  John Cornyn (R-TX) and Pat Toomey (R-PA) have  introduced legislation to repeal Title II of the Dodd-Frank Act, which provide for an orderly liquidation authority for failed financial firms, and replace it with new Chapter 14 of the federal bankruptcy code.  The  Taxpayer Protection and Responsible Resolution Act, S 1861, is designed, said the Senators, to end taxpayer-funded bailouts for large financial institutions. 

The Taxpayer Protection and Responsible Resolution Act strengthens and modernizes U.S. bankruptcy laws to facilitate the resolution of a failed or failing financial institution. The legislation creates a new, specialized bankruptcy chapter (Chapter 14) for certain financial corporations and eliminates the orderly liquidation authority in Title II of the Dodd-Frank Act, which the Senators called  an ad hoc process ripe for political manipulation that provides for yet another bailout.

Under Chapter 14, the failed financial institution would go bankrupt, leaving its owners and long-term creditors on the hook for its bad decisions, not taxpayers. To avoid systemic risk to the financial system, Chapter 14 would enable all the assets and the liabilities of the failed financial firm that pose systemic risk to be transferred to a new bridge company, which would be owned by the bankrupt estate, but  would operate as a new, solvent, company that could go on meeting the failed firm’s obligations.

Senators Nelson and Warren Urge SEC-CFTC Study on High Commissions on Managed-Futures Funds

Senators Bill Nelson (D-FL) and Elizabeth Warren (D-MA) have asked the CFTC, in conjunction with the SEC, to study what specific disclosures and additional investor information might improve the opportunity for investors in all managed-futures funds to retain more of the substantial profits that the industry is making and keeping through what appear, from financial press reports, to be unreasonably high fees, commissions, and expenses. In a letter to CFTC Chair Gary Gensler, the Senators said that one improvement for the protection of unwary investors would be to require that managers of these managed-futures funds clearly explain in writing how severely fees and commissions can consume or affect gross profits over time.  Senator Nelson chairs the Special Committee on Aging, of which Senator Warren is a member.

The legislators emphasized that individual investors, especially senior investors looking to find a suitable place to place their retirement savings, should be made aware of these managed-future funds’ fees and commissions and the draining effect of such upon their investments.  Although these funds are purported to be for sophisticated investors, some of these firms have a very low minimum investment that can be made from an Individual Retirement Account (IRA). The Senators are very concerned about the potential impact that these fees could have on the retirement security of the persons who invest in these funds.

Senator Donnelly Urges SEC and Fed to Protect Collateralized Loan Obligations in Risk Retention Regulations

Senator Joe Donnelly (D-IN) fears the potential negative effects of the proposed regulations implementing the Dodd-Frank credit risk retention provisions on  open-market collateralized loan obligations (CLOs), which he described as an important source of financing to U.S. businesses. He noted that CLOs finance about $300 billion in loans, and such financing supports the expansion of businesses, the employment of more workers, and greater economic growth.

In a letter to SEC Chair Mary Jo White and Fed Chair Janet Yellen, Senator Donnelly acknowledged  that in their August 2013 re-proposal the regulators sought improvements over the original April 2011 proposal to avoid significant disruption to the CLO market. The re-proposed regulations acknowledge that  the agencies' goal in proposing this alternative risk retention option is to avoid having the general risk retention requirements create unnecessary barriers to potential open-market CLO managers sponsoring CLO securitizations. However, despite this language, the Senator said that the regulations  will still unnecessarily restrict the market and result in fewer CLO issuances and less competition. When issuing the final risk retention  regulations, he asked the SEC and bank regulators to carefully consider these concerns.

He added that he supports efforts on risk retention to ensure that complex financial products do not pose grave risks to the greater economy. But in the process of minimizing broader risk, he noted, regulators must strike a balance and do so in a way that does not threaten CLOs, which he views as a vital source of financing. He urged the regulators to ensure that the final regulations do not risk harming the CLO market's ability to fund the business lending that is important to the nation.



Thursday, February 20, 2014

Securities Industry Requests Changes in IRS FATCA Regulations

The securities industry has provided supplemental comments to the U.S. Treasury and the Internal Revenue Service  on the final regulations implementing the provisions of the Foreign Account Tax Compliance Act (FATCA) that were included in section 501 of the Hiring Incentives to Restore Employment Act (HIRE Act).  In a letter to Treasury and the IRS, SIFMA expanded on three specific issues mentioned in its  preliminary comments filed on June 21, 2013.

SIFMA believes that the reason to know standard is excessively broad and should be substantially revised or its implementation delayed. The industry association also asked for further clarification regarding reliance on documentation collected by or certifications provided by other persons and also requested that  the rules regarding electronic transmissions be relaxed and expanded. SIFMA also asked the IRS to grandfather in the “eyeball” test for presuming exempt recipients.
FATCA creates a new reporting and taxing regime for foreign financial institutions with U.S. accountholders. FATCA adds a new Chapter 4 to the Internal Revenue Code, essentially requiring foreign financial institutions to identify their customers who are U.S. persons or U.S.-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, those persons. The Act broadly defines foreign financial institution to comprise not only foreign banks but also any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein. According to the Joint Committee on Taxation, investment vehicles such as hedge funds and private equity funds will fall within this definition. Firms meeting the definition must enter into agreements with the IRS and report information annually in order to avoid a new U.S. withholding tax.

Reason to know standard. In the letter, the securities association pointed out that a FATCA withholding agent is liable for up to the entire amount of FATCA withholding, plus interest and penalties if the agent fails to withhold the correct amount. IRS regulations define "reason to know" very broadly to include constructive knowledge of a wide variety of information that may be stored in paper or electronic files of the withholding agent, including documentation collected for anti-money laundering due diligence purposes, account opening or other customer account files. Interpreting and relating such information to claims of FATCA status requires not only ready access to a large volume of information, noted SIFMA, but a comprehensive understanding of the FATCA regulations and all of the relevant intergovernmental agreements on FATCA compliance and their respective annexes. The standard also requires that withholding agents exercise judgment in cases where information in the possession of the withholding agent might conflict with the payee's claim of FATCA status.

Under an example provided in the regulations, withholding agents would be required to
assess the significance of information contained in financial statements, credit reports, or
other documentation that might be considered by a "reasonably prudent person" to be
inconsistent with an entity's claim to be a non-financial foreign entity (NFFE).

In SIFMA’s view, these new regulations place an extremely high burden on withholding agents and represent a dramatic departure from the existing reason to know standards under Chapter 3 of the Internal Revenue Code, which in the case of financial institutions are generally limited to address checks.

Consequently, because of this extremely burdensome new requirement, and the lack of time or resources to hire and train personnel, connect information systems, and develop protocols for the handling and interpretion of large volumes of information under the still evolving standards of FATCA, and because of the size of penalties for which withholding agents are liable, SIFMA predicts that withholding agents will be compelled to withhold I in many cases because of their inability to establish a payee's FATCA status with sufficient certainty. Thus, SIFMA urged the IRS to substantially narrow, abandon, or delay the implementation of the reason to know standard in the final regulations.

 

Thursday, February 13, 2014

Warner-Corker Mortgage Securitization Legislation Gaining Momentum

The legislation introduced by Senators Mark Warner (D-VA) and Bob Corker (R-TN) to reform the mortgage securitization market is gaining strong bi-partisan support and momentum. Four Republican members of the Senate Banking Committee have now endorsed the Housing Finance Reform and Taxpayer Protection Act, S. 1217, Senators Mike Johanns (R-NE) Mark Kirk (R-IL) Jerry Moran (R-KN) and Dean Heller (R-NV). Senator Saxby Chambliss (R-GA) is also a co-sponsor of S. 1217. They join four  Democratic members of the Committee, Senators Heidi Heitkamp (D-ND), Joe Manchin (D-WV), Jon Tester (D-MT), and Kay Hagan (D-NC) behind the bill. This is very string bi-partisan support for the legislation.

Noting the growing bi-partisan support for S. 1217, Senator Warner issued a statement saying that now is the time to act on the legislation. He said that fixing the government’s role in mortgage finance is the final piece of unfinished business remaining from the financial crisis.  The bill would require that private market participants absorb the first 10 percent of losses on any mortgage-backed security that purchases a government reinsurance wrap. If this standard had been in place during the crisis, said Senator Warner, taxpayers would have taken no losses at all. The legislation also would dissolve Fannie and Freddie within five years, and transfer their responsibilities to a more modernized and streamlined agency. All of this is done with a duty to maximize returns to the taxpayer, via the Treasury, as Fannie and Freddie’s assets are sold off.


Over the past year, the Senate Banking Committee has held 10 public hearings on this important issue, noted Senator Warner and he and Senator Corker  are optimistic that S. 1217 represents a solid framework that can move forward as thoughtful, bipartisan reform. 

Hearings over, Senate Banking Committee Plans Mark Up of Mortgage Securitization Reform Legislation

With the hearing and information-gathering stage on legislation to reform mortgage securitization completed, the Senate Banking Committee is poised to mark up and approve the bi-partisan comprehensive reform legislation.. In a statement, Committee Chair Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID) said that the Committee is ready to dive deep into the drafting and negotiating phase of housing finance reform and the vehicle is the Housing Finance Reform and Taxpayer Protection Act. The goal is to produce the strongest bipartisan bill possible. The legislation should strengthen the housing finance system while ensuring a level playing field for all lenders and access to credit for all creditworthy homebuyers, no matter where they live.


Members of the Banking Committee continue to provide momentum for reform by expressing interest in advancing bi-partisan legislation There is no doubt that enactment of the legislation must be based on a broad bipartisan consensus for an agreement. For these reasons, it remains the Banking Committee’s top priority and, as noted in the State of the Union Address, a priority for the President. As the Banking Committee advances the bipartisan bill, the Chair and Ranking Member are working to include smart, thoughtful ideas from all committee members, the Administration, and others who have participated in the process.

Former NASAA President decries SEC preemption of state review

A Nebraska securities official who was the President of the NASAA during the time Congress considered and passed the JOBS Act, from 2011 to 2012, said he was stunned and dismayed that the SEC would propose preempting the authority of states to register and review Regulation A-Plus offerings as part of the rules proposed  to implement Title IV of the JOBS Act. In a letter to the SEC Jack Herstein, past NASAA chief and currently Assistant Director of the Department of Banking and Finance, averred that Congress plainly did not intend for states to be preempted from registering or reviewing Regulation A-Plus offerings when it enacted Title IV. To the contrary; Congress intended the SEC and the states to be partners in the effort.

Indeed, he continued, the Commission’s decision to propose preempting states under Title IV of the Act by deeming every investor and every offeree in Regulation A-Plus offerings as qualified purchasers is so far removed from both the intentions of Congress and the realities of this new marketplace that it is almost breathtaking.

Citing legislative history, he concluded that Congress carefully and extensively considered whether or not the new exemption established under Title IV of the JOBS Act should preempt state authority. After weighing the perceived merits of preempting state law and the risk to investors that could arise from such action, Congress affirmatively judged that states should not be preempted from review of offerings under the exemption, citing both the high-risk nature of these offerings and the essential function that state review plays in discouraging fraud.



The official added that the preemption of state authority is simply unnecessary. The states understand the need for a modern, efficient, coordinated review process that minimizes the regulatory burden to small business issuers. This is exactly they are engaged in the process of adopting such a new, innovative multi-state review protocol. He said it was disingenuous for the Commission to justify its decision to preempt the states based on criticisms of an “old” Regulation A review process, while barely acknowledging that those criticisms have been addressed by the new protocol.

Monday, February 10, 2014

Senator Vitter Asks SIPC to Review Decision Not to Compensate Stanford Ponzi Scheme Victims

Senator David Vitter (R-LA) asked SIPC to revisit its decision not to compensate the Stanford Ponzi scheme victims. In a letter to Acting SIPC Chair Sharon Bowen, the Senator requested that Chair Bowen reconvene the SIPC board of directors and take a new vote on compensating the victims. Senator Vitter recently told the Acting Chair that because of evidence SIPC never considered concerning the SEC’s directive to compensate the victims, SIPC should revisit the case. Ms. Bowen is curr   ently a nominee for a seat on the CFTC.

Stanford Ponzi scheme. Late last year Senator Vitter sent the Acting SIPC Chair a letter highlighting the role that SIFMA played in the decision not to compensate the Stanford Ponzi scheme victims. He said that SIFMA’s General Counsel was not aware of the details of the Stanford case when they first voted on the Stanford scheme. The SEC concluded that the Stanford victims are entitled to receive SIPC coverage for their losses. The SEC ruling was appealed and the SIPC board refused to compensate. Meanwhile, Senator Vitter has introduced bi-partisan legislation to provide relief to the victims of the Stanford Ponzi scheme by reforming what the Senator calls the ``broken investor protection system.’’

In his latest letter to Acting Chair Bowen, Senator Vitter restated his request that the SIPC Board of Directors reconvene at its earliest opportunity to be presented with all of the factual information available from almost five years of litigation findings in the receivership proceedings that were not considered by the Board prior to its November 2011 vote. Additionally, the Board should take a new vote on this matter in order to ensure that they truly made an informed decision that fulfilled SIPC’s congressionally mandated purpose to provide unbiased governance that represents the public’s interests.

The case arose from a multi-billion-dollar Ponzi scheme run by Allen Stanford and various entities that he controlled, including a bank which issued fixed-return certificates of deposit (CDs) that the bank falsely claimed were backed by safe, liquid investments.  In fact, the claimed investments did not exist, and the bank had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs.

After the fraud was discovered, two groups of Louisiana investors filed suits in state court against a number of Stanford companies and employees claiming violations of Louisiana law. The defendants removed the Louisiana cases to federal court, and all of the actions were ultimately transferred to the Northern District of Texas, which dismissed the complaints as precluded under the Securities Litigation Uniform Standards Act (SLUSA)..  The district court held that, while the CDs themselves were not “covered securities,” the plaintiffs had nevertheless alleged misrepresentations made in connection with transactions in covered securities since the bank said that it invested its assets in highly marketable securities issued by stable governments and strong multinational companies. The district court found that the bank led the plaintiffs to believe that the CDs were backed, at least in part, by investments in SLUSA-covered securities.

The Fifth Circuit reversed, deeming the references to the bank portfolio being backed by covered securities to be merely tangentially related to the heart the defendants’ fraud.  Misrepresentations about the investments were only one of a host of misrepresentations, reasoned the appeals court, which also observed that, because the CDs promised a fixed rate of return, they were not tied to the success of any of the bank’s purported investments in covered securities.

The case is now under appeal to the Supreme Court. Oral argument has been heard amd a decision is expected by June of this year.

In letter to Treasury, Senator Crapo says OFR Asset Management Study Flawed because no SEC Input

Senator Mike Crapo (R-ID), Ranking Member on the Banking Committee, is concerned that the asset management study conducted by the Office of Financial Research was a flawed effort that failed to take into account the perspectives of and data from the SEC and market participants. In a letter to Treasury Secretary Jacob Lew in his capacity as Chair of the Financial Stability Oversight Council, Senator Crapo said that the study resulted in a flawed evaluation of the asset management industry and , even worse, a move towards designating asset management firms as systemically significant financial institutions without an accurate understanding of the role they play in the financial system.

OFR study. He went on to say that the OFR should have engaged in a more transparent and productive way with the SEC and market participants by setting up a transparent process for soliciting comment from the industry and the SEC. who is the primary regulator of asset managers. But unfortunately the OFR did not do this leading to a complete lack of peer review.

This is important, said the Senator because FSOC appears to be contemplating whether or not to designate some asset management firms as systemically important financial institutions. To the extent FSOC intends to rely on information in the OFR study, it is critical that the study contains the best data available and reflects a proper public comment process.

NY Fed Chief Concerned about Cross-Border Application of Dodd-Frank Title II

William Dudley, President of the NY Fed,  is concerned about the cross-border orderly resolution of failed and failing financial institutions that come within the scope of  the orderly liquidation authority in Title II of the Dodd-Frank Act. Specifically, in remarks at a Washington seminar on resolution, the Fed senior official expressed concern that Title II’s one-day stay on the close-out of qualified financial contracts is incomplete and does not extend to contracts governed by non-US law with non-US counterparties.

Title II stay. The placement of the parent company into receivership may be treated by these counterparties as an event of default due to the presence of a parent guarantee or other cross-default provisions triggered by the parent-level insolvency. Unless market participants make the appropriate contractual changes that will ensure that the entry of the parent company into Title II will not trigger the close-out provisions of those over-the-counter derivatives and other qualified financial contracts that are outside the reach of Title II’s U.S. application, he reasoned,  foreign counterparties to the systemically important firm will tend to exercise this right whenever it is in their individual economic interest to do so. This would create significant difficulties because such actions could greatly complicate the operations of the firm during a time when it is already under considerable stress and would propagate stress more broadly in financial markets.

The Fed official said that there are two main options for addressing this issue, and they are not mutually exclusive. Existing derivative contracts could be amended and future contracts could provide that the parent’s entry into the Title II proceeding does not trigger the close-out option, or legal changes could be implemented abroad so that the one-day stay that applies to qualified financial contracts governed by U.S. law is enforceable against those contracts governed by foreign law.

A second issue of  Fed concern with respect to cross-border Title II resolution is that U.S. regulators cannot be certain how foreign authorities will react when the parent is put into the Title II proceeding. U.S. authorities, while they have been in discussion with their colleagues abroad to enable the coordination needed for a smooth cross-border resolution process, cannot always be certain of the circumstances under which host authorities may choose to take or be required to take actions such as unilateral ring-fencing that might disrupt the implementation of the single point of entry approach. He emphasized that U.S. regulators must continue to work with foreign regulators to iron out any issues ahead of time so that the resolution regime will work well for global, systemically important firms.

 

Tuesday, February 04, 2014

Senator Vitter Asks SIPC to Review Decision Not to Compensate Stanford Ponzi Scheme Victims

Senator David Vitter (R-LA) asked SIPC to revisit its decision not to compensate the Stanford Ponzi scheme victims. In a letter to Acting SIPC Chair Sharon Bowen, the Senator requested that Chair Bowen reconvene the SIPC board of directors and take a new vote on compensating the victims. Senator Vitter recently told the Acting Chair that because of evidence SIPC never considered concerning the SEC’s directive to compensate the victims, SIPC should revisit the case. Ms. Bowen is curr   ently a nominee for a seat on the CFTC.

Stanford Ponzi scheme. Late last year Senator Vitter sent the Acting SIPC Chair a letter highlighting the role that SIFMA played in the decision not to compensate the Stanford Ponzi scheme victims. He said that SIFMA’s General Counsel was not aware of the details of the Stanford case when they first voted on the Stanford scheme. The SEC concluded that the Stanford victims are entitled to receive SIPC coverage for their losses. The SEC ruling was appealed and the SIPC board refused to compensate. Meanwhile, Senator Vitter has introduced bi-partisan legislation to provide relief to the victims of the Stanford Ponzi scheme by reforming what the Senator calls the ``broken investor protection system.’’

In his latest letter to Acting Chair Bowen, Senator Vitter restated his request that the SIPC Board of Directors reconvene at its earliest opportunity to be presented with all of the factual information available from almost five years of litigation findings in the receivership proceedings that were not considered by the Board prior to its November 2011 vote. Additionally, the Board should take a new vote on this matter in order to ensure that they truly made an informed decision that fulfilled SIPC’s congressionally mandated purpose to provide unbiased governance that represents the public’s interests.
The case arose from a multi-billion-dollar Ponzi scheme run by Allen Stanford and various entities that he controlled, including a bank which issued fixed-return certificates of deposit (CDs) that the bank falsely claimed were backed by safe, liquid investments.  In fact, the claimed investments did not exist, and the bank had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs.

After the fraud was discovered, two groups of Louisiana investors filed suits in state court against a number of Stanford companies and employees claiming violations of Louisiana law. The defendants removed the Louisiana cases to federal court, and all of the actions were ultimately transferred to the Northern District of Texas, which dismissed the complaints as precluded under the Securities Litigation Uniform Standards Act (SLUSA)..  The district court held that, while the CDs themselves were not “covered securities,” the plaintiffs had nevertheless alleged misrepresentations made in connection with transactions in covered securities since the bank said that it invested its assets in highly marketable securities issued by stable governments and strong multinational companies. The district court found that the bank led the plaintiffs to believe that the CDs were backed, at least in part, by investments in SLUSA-covered securities.

The Fifth Circuit reversed, deeming the references to the bank portfolio being backed by covered securities to be merely tangentially related to the heart the defendants’ fraud.  Misrepresentations about the investments were only one of a host of misrepresentations, reasoned the appeals court, which also observed that, because the CDs promised a fixed rate of return, they were not tied to the success of any of the bank’s purported investments in covered securities.

The case is now under appeal to the Supreme Court. Oral argument has been heard amd a decision is expected by June of this year.


In Letter to Treasury, Senator Crapo Says OFR Asset Management Study Flawed due to no SEC Input

Senator Mike Crapo (R-ID), Ranking Member on the Banking Committee, is concerned that the asset management study conducted by the Office of Financial Research was a flawed effort that failed to take into account the perspectives of and data from the SEC and market participants. In a letter to Treasury Secretary Jacob Lew in his capacity as Chair of the Financial Stability Oversight Council, Senator Crapo said that the study resulted in a flawed evaluation of the asset management industry and , even worse, a move towards designating asset management firms as systemically significant financial institutions without an accurate understanding of the role they play in the financial system.

OFR study. He went on to say that the OFR should have engaged in a more transparent and productive way with the SEC and market participants by setting up a transparent process for soliciting comment from the industry and the SEC. who is the primary regulator of asset managers. But unfortunately the OFR did not do this leading to a complete lack of peer review.


This is important, said the Senator because FSOC appears to be contemplating whether or not to designate some asset management firms as systemically important financial institutions. To the extent FSOC intends to rely on information in the OFR study, it is critical that the study contains the best data available and reflects a proper  public comment process