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Posted on January 23, 2012 by K&L Gates
By: Diane E. Ambler, Andras P. Teleki
On December 29, 2011, the Securities and Exchange Commission (“Commission”) published a final rule release (“Final Rule”) amending the Commission’s rules so as to exclude the value of a person’s primary residence and certain related secured debt from net worth calculations used to determine whether a person qualifies as an “accredited investor” eligible to purchase unregistered securities pursuant to private and other limited offering exemptions under the Securities Act of 1933.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) requires that the accredited investor net worth standard that applies to natural persons individually, or jointly with their spouse, be “more than $1,000,000…excluding the value of the primary residence.” The standard in effect prior to enactment of the Dodd-Frank Act also required a minimum net worth of more than $1,000,000 but allowed the primary residence to be included in the calculation of net worth. The Final Rule revises the Commission’s rules so as to conform to the new standard, which became effective upon enactment of the Dodd-Frank Act on July 21, 2010.
To view the complete alert online, click here.
Posted on January 18, 2012 by K&L Gates
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The 2012 Annual Outlook provides a valuable collection of articles that address important industry and regulatory trends and their correlation with government and political developments. This edition highlights regulatory issues in European Union countries, and also covers diverse topics such as: systemic financial risk regulation, anti-corruption and white-collar enforcement initiatives, tax policies, competition and antitrust law matters, intellectual property and international trade developments, energy and climate change, and health care and food safety laws.
Click here to read the report.
Posted on October 24, 2011 by K&L Gates
By: Rebecca Lobenherz
The CFPB, which has regularly reached out to consumers online through its blog posts and its consumer complaint portal, is also seeking consumer input the old-fashioned way - in person. On October 26, Raj Date, Special Advisor to the Secretary of the Treasury for the CFPB, who previously spoke with consumers in Philadelphia, will be headed to Minneapolis, Minnesota to discuss the Bureau’s upcoming initiatives directly with consumers. The Bureau has plans on holding more events aimed at consumers throughout the country in the upcoming months.
Unlike Mr. Date’s previous speaking engagement in Philadelphia, the Minneapolis town hall event is specifically billed as a forum where members of the community can share their experiences with the consumer credit industry, and specifically with respect to student loans, credit cards, and mortgage loans. The spotlight on these particular consumer financial products should come as no surprise if you have been following the Bureau’s online complaint process, which has been accepting credit card complaints from consumers since the summer and will be expanded to include complaints on mortgages and student loans.
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Posted on October 13, 2011 by K&L Gates
By: Kris D. Kully
The CSBS/AARMR Multistate Mortgage Committee (MMC) released a set of examiner guidelines to assist state regulators in implementing the Federal Reserve Boards loan originator compensation restrictions. Unfortunately, those guidelines provide very little guidance for examiners in determining whether state-regulated mortgage lenders or brokers have complied with those restrictions, or for the lenders or brokers seeking to comply. Like the children's game of Hot Potato, the Federal Reserve Board issued the rulemaking, and then handed it over to the Consumer Financial Protection Bureau, but so far has left interpretation and/or enforcement of the rule to other federal and state agencies. While there are many significant questions that remain in understanding and implementing the loan originator compensation restrictions, the new state CSBS/AARMR examination guidelines do not (and cannot really be expected to) provide those answers. This client alert highlights certain aspects of the guidelines and describes the limited take-aways provided for state-regulated mortgage lenders, brokers, and loan originators.
To view the complete alert online, click here.
Posted on October 12, 2011 by K&L Gates
By: Kathryn M. Baugher
In the months ahead, the CFPB will be expanding the coverage of its consumer complaint portal to include products such as mortgages and student loans. Consumers have been able to submit credit card complaints through a portal on the CFPB web site since July 21st. In addition to providing a consumer portal through which consumers can submit and check on the status of their complaints, the CFPB now provides a company portal through which companies can view and respond to consumer complaints. The CFPB recently met with industry representatives to show them how the new system works.
When a consumer files a complaint through the consumer portal, the CFPB routes the complaint to the company that is the subject of the complaint. The CFPB’s goal is to route each complaint to the appropriate company within 24 to 48 hours of receipt. The company is then expected to communicate directly with the consumer to attempt to resolve the complaint. The CFPB has asked that companies respond to the consumer and update the company portal within 10 calendar days. After logging into the company portal, the company should explain the resolution provided and attach any relevant documents. The company should also select one of the following resolution statuses: full resolution provided, partial resolution provided, no resolution provided, or incorrect company. The CFPB will then e-mail the consumer regarding the status of their complaint and update the complaint status on the consumer portal.
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Posted on October 7, 2011 by K&L Gates
By: Stephanie C. Robinson
Richard Cordray’s nomination to become the director of the Consumer Financial Protection Bureau will be in the hands of the full Senate now that the Senate Banking Committee has approved his nomination along a 12-10 party-line vote. But will the CFPB ever have an official leader in place? Not at this rate.
It has been fourteen months since Congress passed the Dodd-Frank Act, and the new government agency still has no formal leader.
While not challenging Cordray’s credentials, forty-four Republican Senators have vowed not to support any nominee to serve as director. They, like others, protest that a single director would have too much power and not be subject to enough oversight. In a letter sent to the President earlier this year, they wrote, “We believe that the Senate should not consider any nominee to be CFPB director until the CFPB is properly reformed.” They are calling for Democrats to make structural changes to the CFPB, including eliminating the director position and replacing it with a five-member commission, bringing the agency’s funding under congressional control, and making its operations subject to more oversight from other bank regulators. The forty-four Senate Republicans are enough to block Cordray’s approval.
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Posted on October 5, 2011 by K&L Gates
By: Gordon F. Peery, Lawrence B. Patent, Charles R. Mills
The Commodity Futures Trading Commission (“CFTC”) at its open meeting on September 8, 2011, proposed regulations to establish a schedule to phase in the effective dates of future final rules governing swap trading documentation, margin requirements for uncleared swaps, and mandatory swap clearing and trade execution pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Further, CFTC Chairman Gary Gensler announced that the agency would not complete the adoption of all of the final rules implementing Dodd-Frank until at least the first quarter of 2012. Chairman Gensler stated that among the rules that will not be adopted until the first quarter of 2012 are those governing Swap Execution Facilities and the segregation of margin for uncleared swaps. He also stated that the CFTC is considering further exemptive relief from Dodd-Frank’s requirements for swaps.
To view the complete alert online, click here.
Posted on October 4, 2011 by K&L Gates
Understanding the SEC's Changing Role in Mutual Fund Regulation
A Discussion Among Enforcement, Investment Management Execs, and Board Counsel (including investigations and litigation).
Date: Tuesday, November 1, 2011
Time: 4:00 - 5:30 p.m. EST
Location: This program is available to attend live in K&L Gates' Washington, DC office and via webinar.
Live Program: 4:00 - 5:30 p.m.
Reception: 5:30 - 6:30 p.m.
Location:
K&L Gates LLP
1601 K Street, NW
Washington, DC 20006
Webinar Schedule:
Login opens 3:45 p.m.
Program: 4:00 - 5:30 p.m. EST
This event is co-sponsored by the following organizations:
Committee on Broker-Dealer Regulation and SEC Enforcement, DC Bar
Section on Securities Law, Federal Bar Association
The new Asset Management Unit of the SEC's Division of Enforcement is focusing on mutual fund regulatory and governance issues. Mutual fund trustees, executives and counsel want to know what this development means to them and how they should prepare. To this end, K&L Gates and Institutional Investor Intelligence's Fund Director Intelligence have arranged a program that will include panelists from the Securities and Exchange Commission's Division of Enforcement's Asset Management Unit, and Division of Investment Management as well as partners from K&L Gates who work closely with fund boards. Among questions to be addressed are:
- How does the Asset Management Unit interact with the Division of Investment Management?
- Do the two share execution of current and future regulatory goals?
- How do they prioritize goals?
- What tools and personnel does the Asset Management Unit have?
- What is the impact of budgetary constraints?
This timely event will help industry participants better understand the SEC's perspective and challenges and plan for what's ahead.
Panelists:
- Douglas Scheidt, Associate Director and Chief Counsel of the SEC's Division of Investment Management
- Robert Kaplan, Co-Chief of the Asset Management Unit of the SEC's Division of Enforcement
- Eric Purple, Partner at K&L Gates in Washington, D.C.
- Stephen Crimmins, Partner at K&L Gates in Washington, D.C. and New York
Moderators:
- Hillary Jackson, Managing Editor of Fund Director Intelligence, the exclusive information service for independent mutual fund directors that also includes the monthly print issue of Fund Directions.
- Paulita Pike, Partner at K&L Gates in Chicago
Program registration is complimentary. Please note, this event is closed to the press.
To attend live in K&L Gates' Washington, DC office, please click here.
To register for the webinar, please click here.
Webinar login instructions will be circulated via email prior to the program. For those in a different time zone, please feel free to register for the program and a recording of the webinar will be distributed to you and available on our Web site (www.klgates.com) following the program.
Every attendee will receive complimentary access to Fund Director Intelligence for a limited time. Fund Director Intelligence provides practical insight into the key issues facing mutual fund boards. For more information please visit www.FundDirectorIntelligence.com.
For further questions, please email Purvi Patel or call 617.951.9182.
Posted on October 4, 2011 by K&L Gates
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The Impact of Dodd-Frank’s Whistleblower Provisions on FCPA Compliance
Date: Wednesday, October 19, 2011
Time: 11:00 a.m. EDT
Location: via webinar
Webinar Log-in: Opens at 10:45 am EDT
Dodd-Frank’s whistleblower provisions pose significant new challenges for corporate compliance programs, and these issues are particularly acute with respect to Foreign Corrupt Practices Act compliance. Decisions as to whether to self-report potential FCPA violations must be made under enormous time pressures and conditions of great uncertainty.
Please join us for a complimentary webinar as partners from our Government Enforcement practice (one of whom is a former Assistant Director in the FCPA unit of the SEC's Enforcement Division) discuss the current regulatory landscape and how companies might best adapt to these new circumstances.
Topics Include:
- How the SEC is handling whistleblower complaints
- What to expect if your company is the subject of such a complaint
- Cross-border issues that are likely to complicate internal investigations of FCPA matters
Who Should Attend:
- Compliance Officers
- Inside Counsel
Speakers Include:
- Luke T. Cadigan, Partner, Government Enforcement, Boston
- Amy L. Sommers, Partner, Government Enforcement, Shanghai
- Matt T. Morley, Partner, Government Enforcement, Washington, D.C.
- Edward J. Fishman, Partner, Government Enforcement, Washington, D.C.
Program registration is complimentary. To register, please click here by Friday, October 14, 2011.
For further questions, please email Tracey Chuckas or call 202.778.9123.
Posted on October 3, 2011 by K&L Gates
By: Mark D. Perlow, Shoshana L. Thoma-Isgur
On August 29, 2011, the Securities and Exchange Commission took action against a principal partner (the “Partner”) of a registered investment adviser to several private equity funds. The SEC issued an administrative order alleging that the Partner usurped investment opportunities from the adviser’s funds while failing to disclose a conflict of interest, thereby violating the adviser’s code of ethics, as well as violating the anti-fraud provisions of the federal securities laws, and aiding and abetting the violation of other federal securities laws.
To view the complete alert online, click here.
Posted on September 2, 2011 by K&L Gates
By: Mark D. Perlow and Yusef Alexandrine
On July 26, 2011, the SEC voted unanimously to adopt new rules to implement a new system that enables the SEC to monitor large traders’ trading activity through a requirement that broker-dealers record large traders’ activity and report it to the SEC upon its request. The new requirement is intended to assist the SEC’s efforts to analyze and understand the rapid changes in trading technology and market structure. The new rules will apply to certain investment advisers and broker-dealers with discretionary authority over clients’ investments. Using statutory authority that Congress granted to the SEC after the market declines of 1987 and 1989, the SEC has adopted new Rule 13h-1 under the Securities Exchange Act of 1934, which requires “large traders” to register as such with the SEC on new Form 13H and thereby obtain a Large Trader Identification Number (“LTID”) from the SEC. Each large trader is required to disclose its LTID to each broker-dealer through which it or its affiliates trade. Broker-dealers will be required to maintain records of transactions by large traders and “unidentified large traders.” The reporting regime is designed solely for SEC monitoring and not for public disclosure of Forms 13H or any trading activity reported to the SEC. The new large trader reporting rules will become effective on October 3, 2011.
To view the complete alert online, click here.
Posted on July 21, 2011 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Akilah Green, Karishma Shah Page, Collins R. Clark, Nicole B. Ehrbar
July 21, 2011 will be the one year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the most comprehensive reform of the U.S. regulatory framework governing the financial system since the Great Depression. In the year since enactment, there has been an unprecedented flurry of regulatory and Congressional activity.
To view the complete alert, click here.
Posted on July 20, 2011 by K&L Gates
By: Deborah A. Linn, Yusef Alexandrine
On June 22, 2011, the Securities and Exchange Commission (“SEC”) adopted new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Section 410 of Dodd-Frank delineates a new group of advisers with assets under management of between $25 million and $100 million (“Mid-Sized Advisers”) and shifts the primary responsibilities for their regulatory oversight from the SEC to the state securities authorities. Despite the shift to state regulators, under certain circumstances, certain Mid-Sized Advisers may still be eligible to register with the SEC. This Alert will provide a summary of the final rules that affect a Mid-Sized Adviser’s ability to register with the SEC.
To view the complete alert, click here.
Posted on July 20, 2011 by K&L Gates
By: Cary J. Meer, John W. Kaufmann, Jarrod R. Melson
On June 22, 2011, the Securities and Exchange Commission (“SEC”) issued a release adopting rules to implement and define the scope of two new exemptions from registration under the Investment Advisers Act of 1940 (“Advisers Act”). Congress created or directed the SEC to create these exemptions in Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010 ("The Dodd-Frank Act"). The Dodd-Frank Act exempts from registration, among others:
- advisers solely to one or more venture capital funds (“Venture Capital Advisers”), and
- advisers solely to one or more qualifying private funds with aggregate assets under management in the United States of less than $150 million (“Private Fund Advisers”).
The Release adopts rules and definitions that give substance to these exemptions and clarify the terms and methods of their application.
To view the complete alert, click here.
Posted on July 14, 2011 by K&L Gates
In 2011, businesses around the globe have had to react and adapt to an uncommon series of financial, environmental, and political disruptions, while governments seek expanded jurisdiction and pursue vigorous enforcement efforts to resolve their crises. K&L Gates continues to keep abreast of these events and the consequential effect on the relationship between the private and public sectors.
K&L Gates’ Global Government Solutions® 2011 Mid-Year Outlook offers analysis and perspectives on significant regulatory developments and trends for the coming year. Articles address a variety of government-related topics, including an array of financial regulatory reforms (including Dodd-Frank’s whistleblower program and state enforcement of consumer financial laws), the U.S. budget debate, worldwide energy and environmental policies, antitrust enforcement in the health care industry, and competition law issues.
To view the report, click here.
Posted on June 13, 2011 by K&L Gates
By: Cary J. Meer, Deborah A. Linn, Jarrod R. Melson
On May 25, 2011, the Securities and Exchange Commission (the “SEC”) proposed and sought comment on an amendment to Rule 506 of Regulation D under the Securities Act of 1933, as amended (the “1933 Act”), that would address the mandate of Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Section 926 of the Dodd-Frank Act requires that the SEC issue rules within one year of the Dodd-Frank Act’s July 21, 2010 enactment precluding certain “felons and other ‘bad actors’” from participating in offerings of securities that are conducted pursuant to Rule 506 (the most commonly employed “safe harbor” for unregistered private placements of securities). This type of prohibition is commonly referred to as a “bad boy” disqualification.
In this Alert, we briefly discuss:
- The proposed categories of persons that can trigger the “bad boy” disqualification with respect to an issuer’s offering of securities;
- The proposed categories of actions, judgments or other events that trigger disqualification;
- Exceptions to disqualification; and
- Certain key issues raised by the proposed rules for sponsors and investment managers of private investment funds.
To view the complete alert online, click here.
Posted on May 19, 2011 by K&L Gates
By: Howard M. Goldwasser, Sean P. Mahoney, Anthony R.G. Nolan, Drew A. Malakoff
On April 14, 2011, a consortium of U.S. banking, housing and securities regulators (the “Regulators”) proposed joint regulations (the “Proposed Rules”) regarding credit risk retention in securitization. The Proposed Rules would implement Section 15G of the Securities Exchange Act of 1934, which requires the Regulators to prescribe joint regulations to require “any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells or conveys to a third party.”
Generally speaking, a “securitizer” of any securitization would be required to retain at least 5 percent of the credit risk associated with the assets securitized in that transaction, unless an exemption were available under the Proposed Rules. The Proposed Rules prescribe some basic forms of risk retention that could be used in any type of securitization, as well as some forms of risk retention that would apply only to specific types of securitizations (such as those involving revolving asset master trusts, which are common to credit-card and automobile floorplan securitization, CMBS transactions, certain federal agency securities issuances, and ABCP conduits). The detailed requirements of the Proposed Rules would have far-reaching effects on the structure and practice of securitization.
Comments on the Proposed Rules are due on or before June 10, 2011.
To view the complete alert online, click here.
Posted on May 17, 2011 by K&L Gates
By: Ian Fraser, Philip J. Morgan, Victoria Green
The FSA has released Remuneration Policy Statement templates for firms in Proportionality Tiers 2, 3 and 4 of the Remuneration Code, as well as guidance that firms should complete these and have them available for inspection by the FSA from 1 September 2011. Our experience in drafting Remuneration Policy Statements in 2009 and 2010 suggests that firms will need to give significant thought to the disclosures required in these reports and should give themselves sufficient time for preparation, review and sign off in order to meet the 1 September 2011 deadline.
The FSA has also released draft guidance on retention periods, guaranteed variable remuneration and FAQs on the Code, guidance on varying a firm's Proportionality Tier, and a proposal to extend the deadline on implementing share-based awards for non-listed companies by up to one year.
To view the complete alert online, click here.
Posted on May 11, 2011 by K&L Gates
By: Anthony R.G. Nolan, Lawrence B. Patent, Lloyd H. Johnson
On April 12, 2011, the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Fed”), the Federal Deposit Insurance Corporation (the “FDIC”), the Farm Credit Administration (the “FCA”) and the Federal Housing Finance Agency (the “FHFA,” and with the OCC, Fed, FDIC and FCA, collectively, the “Prudential Regulators”) and the Commodity Futures Trading Commission (the “CFTC”) issued proposed rules regarding margin requirements for non-cleared swaps (and, in the case of the Prudential Regulators, security-based swaps) pursuant to the Dodd-Frank Act.
Public comment on the Prudential Regulator Proposed Rules must be submitted on or before June 24, 2011. Public comment on the CFTC Proposed Rules must be submitted by June 27, 2011.
To view the complete alert online, click here.
Posted on April 27, 2011 by K&L Gates
By: Anthony R.G. Nolan, Skanthan Vivekananda
On March 17, 2011 the Securities and Exchange Commission (“SEC”) published for comment a proposed rule intended to “re-adopt” the beneficial ownership reporting requirements under Rules 13d-3 and 16a-1 of the Securities Exchange Act of 1934 (the “Exchange Act”) as they apply to security-based swaps. The proposed rule is one of a series of regulatory initiatives that the SEC has taken to reflect the inclusion of security-based swaps in the definition of “security” for purposes of the Exchange Act and the Securities Act of 1933 and to reflect the repeal of prohibitions that previously had existed in those statutes on the regulation of aspects of security-based swaps.
To view the complete alert online, click here.
Posted on April 4, 2011 by K&L Gates
By: James E. Earle, Mark D. Perlow
On March 30, 2011, seven federal financial regulators published a proposed rule that would implement Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
As required by Section 956 of the Dodd-Frank Act, these joint regulations would prohibit “covered financial institutions” from entering into incentive-based compensation arrangements that encourage inappropriate risks, either because they provide certain covered persons of the covered financial institutions with excessive compensation, or because they could lead to material financial loss to the covered financial institution. As also required under Section 956, the regulations also would require covered financial institutions to disclose the structures of their incentive-based compensation arrangements in a manner sufficient to determine whether the foregoing prohibitions are being properly implemented.
To view the complete alert online, click here.
Posted on March 22, 2011 by K&L Gates
By: Howard M. Goldwasser, Lloyd H. Johnson, Drew A. Malakoff
On January 20, 2011, the Securities and Exchange Commission (the “SEC”) published a final rule under the Securities Act of 1933 (the “Securities Act”) to set requirements for due diligence procedures and disclosure in asset-backed securities offerings. This rule is designed to implement Section 943 of the Dodd-Frank Act.
The new rule, Securities Act Rule 193, requires issuers of publicly offered asset-backed securities (“ABS”) to “perform a review of the pool assets underlying the asset-backed security.” In conjunction with Rule 193, the SEC has amended Item 1111 of Regulation AB to require that issuers also disclose the nature of the review of the assets, the “findings and conclusions” of the review and information regarding the amount and characteristics of assets that deviate from the underwriting criteria.
The Final Rule is effective as of March 28, 2011, but only registered offerings of ABS commencing with an initial bona fide offer after December 31, 2011 must comply with the Final Rule.
To view the complete alert online, click here.
Posted on February 25, 2011 by K&L Gates
By: Susan I. Gault-Brown, Cary J. Meer, Lawrence B. Patent
On January 26, 2011, the Commodity Futures Trading Commission (“CFTC”) proposed rescinding several exemptive rules (the “Private Fund Exemptive Rules”), adopted in 2003, that many operators (general partners/managing members) of private funds that directly or indirectly trade futures contracts and commodity options, and advisers to such funds, rely on to exempt themselves from registration as commodity pool operators (“CPOs”) – Rules 4.13(a)(3) and 4.13(a)(4) – and from registration as commodity trading advisors (“CTAs”) – Rule 4.14(a)(8)(i)(D).
If adopted, the CFTC’s proposal to rescind the Private Fund Exemptive Rules would require operators of private funds that wish to continue or begin trading futures contracts, commodity options, and – as of July 16, 2011 – swaps (together, “commodity interests”), to register as CPOs. Likewise, if adopted, the CFTC proposal would require certain advisers to private funds that continue or begin to trade commodity interests to register as CTAs. Importantly, as of July 21, 2011, many of these advisers will also be subject to investment adviser regulation by either the Securities and Exchange Commission (“SEC”) or one or more states. As a result, if the CFTC’s proposal is adopted, advisers to private funds that trade commodity interests likely will be subject to dual SEC/CFTC regulation.
To view the complete alert online, click here.
Posted on February 21, 2011 by K&L Gates
By: Lorraine Massaro, Anthony R.G. Nolan, Brian M. McNamara
On January 7, 2010, the CFTC proposed regulations (the “Proposed Regulations”) that would apply to the registration and operation of swap execution facilities (“SEFs”), including provisions designed to implement the core principles with which a SEF must comply to be registered and to maintain registration as a SEF under the Commodity Exchange Act (the “CEA”), as amended by the Dodd-Frank Act. The Proposed Regulations also set forth guidance, acceptable practices and other requirements for SEFs. SEFs form a new type of regulated marketplace for the trading of swaps provided for in Sections 5h and 2(h)(8) of the CEA.
To view the complete alert online, click here.
Posted on February 18, 2011 by K&L Gates
By: Susan I. Gault-Brown, Cary J. Meer, Lawrence B. Patent
On January 26, 2011, the Commodity Futures Trading Commission (“CFTC”) proposed amendments to CFTC Rule 4.5. CFTC Rule 4.5 currently excludes certain “qualifying entities,” including registered investment companies (“Registered Funds”), from CFTC regulation as commodity pool operators (“CPOs”). Under the proposed amendments, Registered Funds wishing to continue to claim the Rule 4.5 exclusion from CPO status would be required to limit their use of commodity futures and commodity options, and possibly swaps, and comply with certain marketing restrictions. Significantly, Registered Funds that are unable to operate their current investment programs under the proposed amendments to Rule 4.5 – including, but not limited to, so-called “managed futures” or “commodities strategy” funds and certain registered funds of hedge funds – would be forced either to change their investment program or face dual regulation by the Securities and Exchange Commission (“SEC”) and the CFTC. Among other matters, CFTC regulation would require the operator of such a Registered Fund – likely the Registered Fund’s board of directors – to register as a CPO and could require the Registered Fund’s adviser to register as a commodity trading advisor.
To view the complete alert online, click here
Posted on February 17, 2011 by K&L Gates
By: Arthur C. Delibert, Mark D. Perlow
As directed by the Dodd-Frank Act, the Securities and Exchange Commission and the Commodity Futures Trading Commission on January 26, 2011 jointly proposed new Form PF, which they would use to gather information aimed at evaluating the degree of “systemic risk” presented by certain types of private funds whose managers were either registered with the SEC or jointly registered with the SEC and the CFTC. On the same day, the CFTC also proposed new Form CPO-PQR and Form CTA-PR, which would solicit from commodity pool operators and commodity trading advisors that are registered with the CFTC, but not the SEC, information generally identical to that sought through Form PF. Proposed Form PF encompasses over 60 categories of questions and would collect from private fund managers information unprecedented in its scope and detail.
To view the complete alert online, click here.
Posted on February 17, 2011 by K&L Gates
By: Diane E. Ambler, Mark C. Amorosi
On January 18, 2011, the Financial Stability Oversight Council (the “FSOC”) issued a notice of proposed rulemaking regarding the circumstances under which nonbank financial companies, such as investment managers and broker-dealers, would become subject to supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The notice sets forth a framework that provides broad discretion to the FSOC in making its determinations, which the notice states will be based on a combination of qualitative and quantitative metrics, but it provides little clarity on the metrics or other factors that would cause the FSOC to designate a nonbank financial company as systemically important enough to be under supervisory authority of the Federal Reserve.
To view the complete alert online, click here.
Posted on February 4, 2011 by K&L Gates
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K&L Gates continues to monitor and analyze the shifting relationships between business and government worldwide, as governments around the globe are increasingly involved in the economy and the private sector. Effectively navigating these dynamic relationships has become a significant challenge for organizations large and small.
K&L Gates' Global Government Solutions 2011 Annual Outlook contains informative articles on some of the most consequential government developments that we anticipate in 2011. Among the topics covered are the implementation of the Dodd-Frank financial reform law and the Basel III accords on international financial regulation, the global convergence of competition law, changes in the health care industry and related regulations, environmental and energy policies, aggressive regulatory and law enforcement efforts, and changes in the political landscape.
To view the report, click here.
Posted on February 2, 2011 by K&L Gates
By: Anthony R.G. Nolan, Drew A. Malakoff, Shawn McBride, Lynwood E. Reinhardt
On January 4, 2011, the SEC published for comment new and amended rules under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that set forth the conditions under which issuers of publicly registered ABS may suspend the obligation to file periodic Exchange Act reports. The proposed rules are intended to implement the disclosure requirements contained in Section 942(a) of the Dodd-Frank Act.
In conjunction with the proposed rule, the SEC staff also published a no-action letter that provides for limited grandfather protection for Exchange Act reporting requirements of issuers of registered ABS that had been issued during or prior to 2009.
Comments on the proposed rules must be submitted by February 7, 2011.
To view the complete alert online, click here.
Posted on January 28, 2011 by K&L Gates
By: Anthony R.G. Nolan, Gordon F. Peery, Drew A. Kelly
On December 15, 2010, the CFTC proposed a comprehensive set of principle-based regulations that would establish standards of compliance for derivatives clearing organizations DCOs. The proposed regulations would establish the standards of compliance for relating to (i) reporting; (ii) recordkeeping; (iii) public information; and (iv) information sharing. The proposed regulations are designed to implement Section 5b(c)(2) of the Commodity Exchange Act, as amended by Section 725(c) of the Dodd-Frank Act.
Public comments on the proposed rules must be filed with the CFTC on or before February 14, 2011.
To view the complete alert online, click here.
Posted on January 25, 2011 by K&L Gates
By: Philip M. Cedar, Angela L. Cottrell
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amended Section 15B of the Securities Exchange Act of 1934 to (i) require municipal advisors to register with the Securities and Exchange Commission (“SEC” or the “Commission”), (ii) grant the Municipal Securities Rulemaking Board regulatory authority over municipal advisors and (iii) impose a fiduciary duty on municipal advisors when advising municipal entities. On December 20, 2010, the Commission proposed Rules 15Ba1-1 through 15Ba1-7 (the “Proposed Rules”), which would establish a permanent registration regime for municipal advisors by, among other matters, creating a set of disclosure forms for both municipal advisory entities and certain of their employees to file with the Commission and be made publicly available. The Proposed Rules also provide additional guidance as to the activities that would require registration as a municipal advisor and impose certain record-keeping requirements on such advisors. If adopted, the Proposed Rules would replace the temporary, more limited registration requirements under interim Rule 15Ba2-6T, which became effective on October 1, 2010, which the SEC issued to comply with a deadline imposed by the Dodd-Frank Act.
To view the complete alert online, click here.
Posted on January 21, 2011 by K&L Gates
By: Philip M. Cedar, Stacey H. Crawshaw-Lewis, Lawrence B. Patent, Lloyd H. Johnson
On December 9, 2010, the CFTC proposed for comment a far-reaching set of business conduct rules (collectively, the “Proposed Regulation”) to govern swap dealers (“SDs”) and major swap participants (“MSPs”) in their dealings with counterparties. The Proposed Regulation would prohibit certain fraudulent and abusive practices and impose significant disclosure, diligence, suitability and transaction execution obligations on SDs and MSPs. In addition, where an SD or MSP acts as an advisor to a counterparty that is a “Special Entity,” including certain governmental entities, municipalities, employee and governmental benefit plans and endowments, it must act in the “best interests” of such Special Entity and have a reasonable basis to believe that the Special Entity has a qualified representative meeting certain sophistication and independence criteria. The Proposed Regulation also contains “pay-to-play” provisions that would prohibit SDs and MSPs from entering into swaps with municipal entities if they make certain political contributions to officials of such entities.
To view the complete alert online, click here.
Posted on January 18, 2011 by K&L Gates
By: Lawrence B. Patent
On December 9, 2010, the CFTC adopted an interim final rule (the “IFR”) regarding the reporting of information about “transition swaps” (which are defined as swap transactions that have been entered into after July 21, 2010, the date of enactment of the Dodd-Frank Act, and prior to the effective date of the swap data reporting and recordkeeping rules implementing the Dodd-Frank Act).
Under the IFR, transition swaps must be reported (the mechanics of which are discussed below) in accordance with the requirements set forth in new Section 2(h)(5)(B) of the Commodity Exchange Act (the “CEA”), which was added by Section 723 of the Dodd-Frank Act. CEA Section 2(h)(5)(B) generally requires parties to transition swaps to report certain information regarding such swaps to a swap data repository or to the CFTC. Because rules implementing the reporting requirements of CEA Section 2(h)(5)(B) have yet to be put into effect, the CFTC adopted this IFR to regulate the reporting and record retention relating to transition swaps before such rules become effective.
Although open for comment, the IFR is binding on swap market participants from its date of adoption.
To view the complete alert online, click here.
Posted on January 14, 2011 by K&L Gates
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Date: Wednesday, February 9, 2011
Time: 11:30 – 1:00 p.m. CST
Location: via webinar
Webinar Log-in: Opens at 11:15 am CT
Please join us for an informative lunch program presenting an overview of the requirements of the Investment Advisers Act of 1940, including a discussion of amended Form ADV Part 2. The program is designed for currently registered investment advisers.
Topics Include:
- A guide to amended Form ADV Part 2's disclosure requirements
- A discussion of the SEC's proposed changes to Part 1 of Form ADV
- Other changes to investment adviser registration
Panelists:
Program registration is complimentary. To register, please click here.
For further questions, please email Carolyn Verscaj or call 312.558.7394.
Posted on January 13, 2011 by K&L Gates
By: Joel D. Almquist, Thomas F. Joyce, Theodore L. Press, Roger S. Wise
On December 22, 2010, President Obama signed the Regulated Investment Company (“RIC”) Modernization Act of 2010 (the “Act”), which provides necessary and long-sought improvements to many procedural and operational RIC rules. The Act expands the cure provisions for inadvertent failures to comply with certain RIC qualification requirements, rationalizes the manner in which the character of RIC dividends is determined and reported, and eliminates the application to RICs of certain corporate tax rules that are relevant to types of corporations other than RICs. However, the Act does not contain a potentially far-reaching provision in an earlier version of the legislation to treat commodities-based income as “good income” for RICs.
To view the complete alert online, click here.
Posted on January 6, 2011 by K&L Gates
By: Lawrence B. Patent
On December 1, 2010, the CFTC proposed regulations under Section 725 of the Dodd-Frank Act that would establish standards by which derivatives clearing organizations (“DCOs”) must demonstrate compliance with certain core principles, as well as requirements for a DCO chief compliance officer, as set forth in Section 5b of the Commodity Exchange Act. The proposed regulations would also make certain technical amendments to other existing CFTC regulations to conform to requirements of the Dodd-Frank Act.
This alert discusses the Dodd-Frank Act’s grant of explicit rulemaking authority to the CFTC concerning DCOs, which could lead to requirements on DCOs beyond those established by the statutory core principles, an expansion of the core principle related to antitrust, as well as a new core principle added by the Dodd-Frank Act regarding legal risk.
Public comment on the proposed regulations may be filed with the CFTC on or before February 11, 2011.
To view the complete alert online, click here.
Posted on January 5, 2011 by K&L Gates
By: Susan I. Gault-Brown, Anthony R.G. Nolan, Lawrence B. Patent
On December 21, 2010, the Commodity Futures Trading Commission and the Securities and Exchange Commission jointly proposed rules to clarify the Dodd-Frank Act definitions of the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” and “major security-based swap participant,” and “eligible contract participant.” The proposed definitions, if finalized as proposed, would provide greater clarity to the scope of the definitions of those terms as used in the Dodd-Frank Act but would also have profound implications for a large number of participants in the swap and security-based swap market.
To view the complete alert online, click here.
Posted on January 3, 2011 by K&L Gates
Thursday: February 3, 2011 - 4:00 - 5:30 p.m. EST
Please join us for an exciting program on the SEC Division of Enforcement's recently announced focus on mutual fund fees, which brings new scrutiny and challenges for independent directors. The Division’s asset management unit has developed new analytics to examine mutual fund fees and determine whether they are excessive, and it plans to investigate outlier fees and the process under which they were approved, including whether directors fulfilled their 15(c) duties and were provided with all relevant information to conduct their review.
What does this mean for mutual fund directors like yourself? A panel of legal experts, trustees, and the managing editor of a leading trade publication for independent directors will discuss:
- The SEC Unit’s current focus
- Directors’ fiduciary obligations in the 15(c) process
- Legal issues post-Jones v. Harris issues
- Past enforcement actions and lessons learned
Moderator:
- Melissa Karsh, Managing Editor of Fund Directions, a leading news service for independent fund directors at mutual fund companies.
Panelists:
- Paul H. Dykstra, Partner at K&L Gates in Chicago, represents mutual funds or their boards throughout the U.S. He also counsels independent fund directors involved in corporate reorganizations and internal or SEC investigations.
- Sam Freedman, Independent Trustee and Chairman of the Review Committee for Oppenheimer Funds (Denver Board).
- Roger B. Vincent, Independent Chairman of the Board of Directors for various ING Funds.
- Robert J. Zutz, Partner at K&L Gates in Washington, D.C., represents investment companies, their independent directors and trustees, investment advisers and broker-dealers throughout the U.S.
This program is complimentary and will be offered live in K&L Gates' New York office and via webinar.
To attend in person, please click on the link below.
Live Location:
K&L Gates LLP
599 Lexington Avenue
New York, NY 10222
To join the webinar, please click on the link below. Note: webinar instructions will be circulated via email prior to the program.
For further questions, please email Purvi Patel or call 617.951.9182.
Posted on December 27, 2010 by K&L Gates
By Gordon F. Peery, Lawrence B. Patent, Charles R. Mills.
The Commodity Futures Trading Commission (“CFTC”) recently has proposed registration requirements for swap dealers (“SDs”) and major swap participants (“MSPs,” and collectively with SDs, “Swap Entities”) and their principals. Registration as an SD or MSP would be required for all persons that come within the definitions of those terms, regardless of whether such person also is registered in another capacity under the Commodity Exchange Act (“CEA”). The proposed registration regulations also would require Swap Entities to become members of the National Futures Association. Significantly, unlike the CFTC’s current rules governing foreign brokers, the Proposing Release does not provide a framework for exemption from CEA registration for Swap Entities that are otherwise registered with non-U.S. derivatives regulators.
To view the complete alert online, click here.
Posted on December 22, 2010 by K&L Gates
By Ian Fraser, Victoria Green, Philip J. Morgan.
On 17 December, the UK's Financial Services Authority published the final text of its revised Code of Practice on remuneration. The Code will apply from 1 January 2011 onwards to all FSA-regulated banks, building societies and investment firms that fall within the scope of the EU's Markets in Financial Instruments Directive (MiFID).
The Code has the following main implications:
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The approximately 26 biggest banks, building societies and broker-dealers operating in the UK continue to be subject to the Code but have additional requirements for remuneration design and delivery and new reporting and public disclosure obligations;
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Another approximately 2,500 financial services firms, including investment advisers, fund managers and smaller banks and broker dealers, will now be subject to the Code. However, for most of these firms a "proportionality principle" should mean that some of the Code's provisions can be "neutralised" and that lower levels of reporting and public disclosure should apply.
To view the complete alert online, click here.
Posted on December 17, 2010 by K&L Gates
By John W. Kaufmann, Jarrod R. Melson.
On November 19, 2010, the Securities and Exchange Commission issued a release proposing rules to implement and define the scope of two new exemptions from registration under the Investment Advisers Act of 1940. Congress created or directed the SEC to create these exemptions in Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010. The Dodd-Frank Act exempts from registration, among others:
- an adviser solely to one or more venture capital funds (“Venture Capital Advisers”), and
- an adviser solely to one or more private funds with aggregate assets under management in the United States of less than $150 million (“Private Fund Advisers”).
The release proposes rules and definitions that give substance to these exemptions and clarify the terms and methods of their application, but leave many issues unaddressed. This alert discusses each exemption and the proposed rules in the release relating to such exemptions.
To view the complete alert online, click here.
Posted on December 16, 2010 by K&L Gates
By: Alan P. Goldberg
In companion releases designed to implement the provisions of the Dodd-Frank Act, the SEC recently proposed rules under the Advisers Act to, among other matters, implement the registration of private fund advisers with the SEC, enunciate proposed reporting requirements for hedge fund and other investment advisers, as well as reporting requirements for “exempted advisers,” reallocate regulatory responsibility, and define exemptions for advisers to venture capital funds, private fund advisers with less than $150 million under management (“Exempt Reporting Advisers”) and foreign private advisers.
The SEC also took the opportunity in these releases to propose rules that would require advisers to provide additional information about three areas of their operations:
- the private funds they advise;
- the data that advisers provide about their advisory business; and
- advisers’ non-advisory activities and their financial industry affiliations.
The SEC also proposed certain additional changes intended to improve its ability to assess compliance risks and to identify advisers that are subject to the Dodd-Frank Act’s requirements concerning certain incentive-based compensation arrangements. This alert outlines these proposed new disclosure requirements, which the SEC noted are designed to assist it in assessing the risk of the adviser.
To view the complete alert online, click here.
Posted on December 16, 2010 by K&L Gates
By: Deborah A. Linn, Joanne F. Osberg
On November 19, 2010, the Securities and Exchange Commission proposed new and amended rules under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 410 of Dodd-Frank delineates a new group of advisers with assets under management of between $25 million and $100 million (“Mid-Sized Advisers”) and shifted the primary responsibilities for their regulatory oversight from the SEC to the state securities authorities. Despite the shift primarily to state regulators, under certain circumstances certain Mid-Sized Advisers may register with the SEC. This alert provides a summary of the proposed provisions that affect a Mid-Sized Adviser’s ability to register with the SEC.
To view the complete alert online, click here.
Posted on December 14, 2010 by K&L Gates
By Stephen J. Crimmins.
For decades, the Securities and Exchange Commission’s Enforcement Division allocated few of its limited resources to the the world of registered funds, private funds and advisers. The Investment Advisers Act and the Investment Company Act were left to the regulatory lawyers while, apart from the combined state-federal campaign against market timing and late trading a few years ago, the enforcement lawyers directed their investigations and litigation elsewhere.
This largely hands-off approach changed dramatically when the SEC’s new Enforcement Director Robert Khuzami announced that his restructuring efforts would include the creation of a new “Asset Management Unit” within the Division to focus squarely on investigating and bringing enforcement cases against investment advisers, investment companies, hedge funds and private equity funds. This article discusses the Asset Management Unit’s formation and structure, its recently announced initiatives impacting funds and advisers, and prosecutorial interests discernable from the cases it has announced so far.
To view the complete article online, click here.
Posted on December 14, 2010 by K&L Gates
By: Ian Fraser, Philip J. Morgan, Victoria Green
On 10 December, the Committee of European Banking Supervisors (CEBS) published their final guidelines on remuneration policies and practices required by recent amendments to the EU Capital Requirements Directive (known as CRD III). Member States of the European Economic Area (EEA) must apply CRD III from 1 January 2011 onwards to all EEA credit institutions and firms that fall within the scope of the EU's Markets in Financial Instruments Directive (MiFID). This includes most banks, building societies, investment advisers, fund managers and broker-dealers (including branches and subsidiaries of Non-EEA firms) except, broadly, those that do not hold client money and only provide advice and arrange deals.
The CEBS Guidelines are intended to clarify some of the requirements under CRD III and will be taken into account by regulatory authorities in the EEA. The FSA's revised Remuneration Code will reflect the FSA's interpretation of these Guidelines and will be published shortly. We will release a further alert summarising the key implications of the final Remuneration Code once this has been released by the FSA.
To view the complete article online, click here.
Posted on December 13, 2010 by K&L Gates
By: Donald A. Kaplan, Charles R. Mills, Anthony R.G. Nolan, Lawrence B. Patent
The CFTC recently published six proposed regulations delineating the duties of swap dealers (“SDs”) and major swap participants (“MSPs”) relating to (i) risk management procedures; (ii) monitoring trading to prevent violations of applicable position limits; (iii) diligent supervision; (iv) business continuity and disaster recovery; (v) disclosure to and access by regulators of general information; and (vi) antitrust considerations. The proposed regulations are designed to implement the registration and regulatory requirements of new Section 4s(j) of the Commodity Exchange Act (the “CEA”), which was adopted pursuant to Section 731 of the Dodd-Frank Act.
To view the complete alert online, click here.
Posted on December 9, 2010 by K&L Gates
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December 14, 2010 11:00 a.m. - 12:30 p.m. EST
Please join us for a complimentary webinar as our panel discusses the best practices and emerging trends in global private placements in today's global economy.
Topics Include:
- US Private Placements of Private Funds - A Quick Review and How
Dodd-Frank Affects Them
- Dodd Frank - Private Fund Report Requirements
- Dodd Frank - Investment Adviser Registration Requirements and the
Foreign Adviser
- Adviser Registration - What it Means in Practice
- Products and Services Needed by Advisers After Dodd-Frank
- EU Private Placements Today
- The AIFMD: The End of EU Private Placements as We Know Them?
- UCITS IV: The Alternative Directive to the AIFMD?
To register, please click here.
Posted on December 6, 2010 by K&L Gates
By: Edward G. Eisert, Philip J. Morgan, Sarah E. Connolly, Richard A. Dollimore, Jarrod R. Melson
On November 11, 2010, the European Parliament of the European Union (the “EU”) approved the “Proposal for a Directive of the European Parliament and of the Council on Alternative Investment Fund Managers” (the “Directive”). First proposed in April 2009 in response to the financial crises, the Directive seeks to provide a harmonized EU regulatory framework for the supervision and operation of alternative investment fund managers (“Managers”) and is expected to have far-reaching consequences for the funds industry both in the EU and elsewhere.
Broadly, the Directive will apply to: (i) Managers with a registered office in the EU; and (ii) all other Managers that manage and/or market alternative investment funds in the EU. For purposes of the Directive, “Funds” include hedge funds, private equity funds, real estate funds, infrastructure funds, mutual funds domiciled and registered in the United States, and all other collective investment undertakings that are not compliant with the EU Undertakings for Collective Investments in Transferable Securities Directive.
The timing and the degree of impact of the Directive on any particular U.S. Manager will vary based upon the factors discussed below. A more detailed discussion of the Directive is available in the accompanying Analysis.
To view the complete alert online, click here.
To view the accompanying Analysis, click here.
Posted on December 2, 2010 by K&L Gates
By Ian Fraser, Philip J. Morgan, Victoria Green
The UK FSA has released a consultation paper on reporting requirements under the FSA's Remuneration Code, which could be of relevance to US banks and investment firms operating through a UK subsidiary or branch. While the full implications of the revised Remuneration Code for the 2,500 firms within its scope will remain uncertain until the final Code is published in mid-December, it is clear from the consultation paper that all in-scope firms will be expected to make public disclosures regarding their remuneration policies at least in respect of:
- corporate governance processes relating to remuneration policy;
- information on the link between pay and performance; and
- aggregate quantitative information on remuneration, broken down by (i) business area and (ii) senior management and members of staff whose actions have a material impact on the firm’s risk profile.
All firms within the scope of the Remuneration Code will need to determine the level of disclosure that applies to them and how disclosures should be presented to the public. Please contact any of the authors to discuss any aspect of the Remuneration Code.
To view the complete alert online, click here.
Posted on December 1, 2010 by K&L Gates
By Phillip L. Schulman, Rebecca Lobenherz
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As if lenders do not have enough to worry about these days with the myriad of federal and state mortgage reforms, on November 17, 2010, the U.S. Department of Housing and Urban Development released Mortgagee Letter 2010-38 (ML 2010-38), which clarifies mortgagee eligibility requirements to participate in Federal Housing Administration (FHA) programs and provides information regarding the FHA Annual Certification process. Just in time for the end of many mortgagees' fiscal years and the start of the recertification process, ML 2010-38 makes it much harder for many, if not most, lenders to complete their annual FHA renewals.
To view the complete alert online, click here.
Posted on November 29, 2010 by K&L Gates
By: Susan I. Gault-Brown, Anthony R.G. Nolan, Robert A. Wittie
On November 3, 2010, the Securities and Exchange Commission published for comment a proposed rule intended to implement anti-fraud and anti-manipulation provisions regarding security-based swaps pursuant to Section 763(g) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Proposed Rule 9j-1 under the Securities Exchange Act of 1934 would make it unlawful for any person to directly or indirectly engage in fraud, manipulation or deception in connection with the offer, purchase or sale of any security-based swap, as well as “the exercise of any right or performance of any obligation under” a security-based swap. The proposed rule is intended to make clear that the fraud and manipulation protections of the federal securities laws apply not only to offers, purchases and sales of security-based swaps but also explicitly to “the cash flows, payments, deliveries, and other ongoing obligations and rights that are specific to security-based swaps.”
Comments are due on or before December 23, 2010.
To view the complete alert online, click here.
Posted on November 19, 2010 by K&L Gates
By Cary J. Meer, David Mishel, Sonia R. Gioseffi.
Effective January 1, 2011, placement agents (as defined below) who act as intermediaries in connection with a potential investment by a California state public pension system must register with the California Secretary of State as lobbyists, while placement agents who act in connection with a potential investment by a local California pension system will be required to register as lobbyists and file reports with the locality if required by a local government agency. In addition, placement agents may not accept contingent fees in connection with an investment by a California state public pension system. California state public pension systems include the California Public Employees’ Retirement System (“CalPERS”) and the California State Teachers’ Retirement System (“CalSTRS”). Local government agencies are authorized to adopt their own regulations, including requirements regarding contingent fees.
To view the complete alert online, click here.
Posted on November 19, 2010 by K&L Gates
By Lawrence B. Patent.
On November 2, 2010, the Commodity Futures Trading Commission (“CFTC”) published a proposed new reporting framework for swaps based on physical commodities similar to the CFTC’s current large trader reporting regime for exchange-traded futures contracts. The public comment period ends December 2, 2010.
The proposed regulations would require clearing organizations, clearing firms and swap dealers to report to the CFTC daily, on an account-by-account basis, their aggregate proprietary and customer positions in swaps that are economically equivalent to the exchange-traded futures contracts on physical commodities specified in the proposed regulations. Although the proposed regulations would not require commercial end-users to file daily reports, they would require end-users to keep records relating to reported swap positions and related cash and futures market transactions.
The CFTC has proposed its new Part 20 regulations pursuant to Section 737(a)(4) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added new Section 4a(a)(5) of the Commodity Exchange Act that authorizes the CFTC, as appropriate, to establish speculative position limits for swaps based upon physical commodities that are economically equivalent to exchange-traded futures or option contracts. The proposed reporting framework is intended to provide the CFTC with the swap market information it needs to develop speculative position limits for swaps based upon physical commodities that are economically equivalent to exchange-traded futures contracts on the same commodities.
To view the complete alert online, click here.
Posted on November 10, 2010 by K&L Gates
By Diane E. Ambler, Mark R. Greer.
The staff of the Securities and Exchange Commission (“SEC”) recently published long-awaited guidance “clarifying” the responsibilities of mutual fund directors when they make the determinations required by Rules 10f-3, 17a-7 and 17e-1 of the Investment Company Act of 1940. The guidance was delivered in the form of a letter to the Independent Directors Council and the Mutual Fund Directors Forum (the “Letter”). The Letter marks the culmination of SEC Division of Investment Management Director Andrew “Buddy” Donohue’s “Director Outreach Initiative” and offers some relief for boards when reviewing transactions between a fund and its adviser under Rule 10f-3 (permitting a fund to purchase securities from an affiliated syndicate), Rule 17a-7 (permitting a fund to engage in certain cross-trading) or Rule 17e-1 (permitting a fund to use an affiliated broker). Among other things, these Rules require that the board of a fund that relies on the Rules undertake quarterly reviews and make certain determinations related to the potential conflicts of interest present.
To view the complete alert online, click here.
Posted on November 4, 2010 by K&L Gates
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The Fall 2010 Edition of K&L Gates' Investment Management newsletter is offered as a timely aid in addressing the myriad regulatory issues confronting the investment management industry. Watch for future issues discussing up-to-the-minute developments and trends in the industry.
To view the complete newsletter online, click here.
Posted on November 3, 2010 by K&L Gates
The U.S. Department of Labor (“DOL”) recently released a proposed regulation that would greatly expand the circumstances in which a person could be considered a “fiduciary” under the Employee Retirement Income Security Act of 1974 (“ERISA”) when providing non-discretionary investment advice. ERISA provides that a person (either an individual or an entity) that provides investment advice for a fee is a fiduciary. An existing DOL regulation sets out a long-standing and widely accepted method of determining when a person is providing investment advice for purposes of ERISA. The proposed regulation would dramatically change this method and, therefore, is likely to prove very controversial. Public comments on the proposed regulation are due by January 20, 2011.
To view the complete alert online, click here.
Posted on October 27, 2010 by K&L Gates
By Kay A. Gordon, Kenneth G. Juster.
On October 12, 2010, the Securities and Exchange Commission staff granted no-action relief under Section 206(4) of the Investment Advisers Act of 1940, as amended and Rule 206(4)-2 thereunder (the “Custody Rule”) to allow advisers to private funds to continue to use their current auditors to satisfy the Annual Audit Provision (defined below) in the case that these auditors are not currently subject to regular inspection by the Public Company Accounting Oversight Board (“PCAOB”). Absent this relief, the use of such auditors would potentially subject fund advisers to the application of the surprise audit requirement under the Custody Rule. This relief expires upon adoption of rules concerning the inspection of auditors of broker-dealers by the PCAOB or July 21, 2011, whichever date is earlier.
To view the complete alert online, click here.
Posted on October 26, 2010 by K&L Gates
By: Jeffrey W. Acre
On October 18, 2010, the Securities and Exchange Commission (the “SEC”) proposed various new rules and amendments to existing rules (collectively, the “Proposed Rules”) to implement controversial provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) dealing with shareholder approval of a company’s executive compensation (commonly referred to as “say-on-pay”) and compensation arrangements between named executive officers and companies involved in certain significant transactions (commonly referred to as “golden parachute” compensation). This alert summarizes the key aspects of the Proposed Rules, including timing and transition matters.
To view the complete alert online, click here.
Posted on October 25, 2010 by K&L Gates
by Kay A. Gordon, Philip J. Morgan, Benoit N. Jacqmotte.
In the wake of the global financial crisis and recent instability in the European sovereign debt markets, the European Commission has issued a proposal for a regulation addressing short selling and certain aspects of credit default swaps. In contrast to a directive, which must be transposed into the laws of each member state of the European Union (the “EU”), a regulation is directly applicable in all EU member states.
To view the complete alert online, click here.
Posted on October 4, 2010 by K&L Gates
K&L Gates Webinar: Competing Globally in the Asset Management Industry
Date/Time: Tuesday, October 19, 2010 from 8:30 - 10:00 a.m. EDT
Location: Attend via Webinar. Webinar log-in instructions will be circulated via email prior to the program.
RSVP: click here to register online.
What issues do investment advisers need to address when offering services and funds worldwide? Please join us for a complimentary Breakfast Briefing that will answer that question and many more. Our panel will focus on a few key jurisdictions, and how you can penetrate their marketplaces.
Spotlight on Hong Kong: The Hong Kong funds market, best practices and regulatory procedures for foreign investment advisers and their funds operating in the Hong Kong market.
Focus on Taiwan: What offshore advisers need to know to do business in Taiwan; best practices, regulatory procedures and latest developments on tax issues for foreign investment advisers and their funds operating in Taiwan.
Eye on Europe: Considerations for foreign investment advisers in the European market, including highlights of the Alternative Investment Funds Management Directive and UCITS IV.
Panelists:
Stuart E. Fross, K&L Gates Partner, Boston Office
Rebecca O'Brien Radford, K&L Gates Partner, Boston Office
Choo Lye Tan, K&L Gates Partner, Hong Kong Office
Christina C.Y. Yang, K&L Gates Partner, Taipei Office
Webinar log-in instructions will be circulated via email prior to the program.
Program registration is complimentary. To register, please click here.
For further questions, please email Purvi Patel or call 617.951.9182.
Posted on August 31, 2010 by K&L Gates
K&L Gates Webinar: HUD Interpretive Rule – Are Marketing Agreements Under Siege?
Date/Time: Tuesday, September 14, 2010 at 2:00 p.m. EDT
Location: Attend via Webinar. Login directions will be distributed via email the day before the event.
RSVP: Click here to register online. Registration closes at 5:00 p.m. EDT on September 10.
As Section 8 of the Real Estate Settlement Procedures Act ("RESPA") provides an exemption for payments made by one person to another person for actual, necessary, and distinct services, mortgage lenders, homebuilders, real estate brokers, title insurance companies, and other settlement service providers have maintained marketing agreements for decades without much guidance from the U.S. Department of Housing and Urban Development ("HUD"). That all changed on June 25, 2010 when HUD issued a RESPA interpretive rule regarding the permissibility of marketing agreements between home warranty companies and real estate brokers and agents. Although the interpretive rule provided RESPA guidance in the limited circumstance of per-transaction home warranty marketing agreements, HUD's interpretation has caused settlement service providers generally to question the RESPA compliance of flat fee marketing and service agreements, as well as the permissible types of marketing services performed under these agreements.
Join us on Tuesday, September 14, 2010 from 2:00 p.m. until 3:15 p.m. Eastern Daylight Time for a webinar to learn more about HUD's interpretive rule and the effects this interpretation could have on your existing marketing agreements. Time for questions and answers will follow the webinar presentation.
Speakers Include:
Posted on August 27, 2010 by K&L Gates
By: Ian Fraser, Philip J. Morgan, Victoria Green
The FSA has published a consultation paper proposing significant changes to its Remuneration Code, including a major increase in scope from the approximately 27 largest banks, building societies and broker-dealers operating in the UK that are currently covered to over 2,500 FSA-authorised banks, building societies, asset managers, UCITS investment firms and some firms engaged in corporate finance, venture capital, the provision of financial advice and stockbrokers. The asset managers within the scope of the proposed rules are those to which the Markets in Financial Instruments Directive rules apply, other than so-called exempt CAD firms which do not exercise investment discretion.
To view the complete alert online, click here.
Posted on August 17, 2010 by K&L Gates
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act") represents the most dramatic revision of the U.S. financial regulatory framework since the Great Depression.
K&L Gates lawyers and policy professionals have been actively involved in many aspects of the Dodd-Frank Act and have sought to provide our clients and friends with updated information and analysis on some of its key provisions. Through focused and coordinated efforts of our Financial Services, Corporate and Policy and Regulatory practice areas, K&L Gates has prepared a series of alerts on key provisions of the Act. Below we list the financial reform alerts that we have distributed to date on the Dodd-Frank Act, all of which may be accessed electronically through a link to our Financial Reform webpage.
To view the complete alert online, click here.
Posted on August 6, 2010 by K&L Gates
By: Diane E. Ambler, Edward G. Eisert, Alan P. Goldberg, Mary C. Moynihan, Stevens T. Kelly
The core provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) for the most part focus on areas of the financial services industry other than the registered fund sector. However, the Dodd-Frank Act’s sweeping expansion of federal regulation in the financial sector will affect investment companies and the investment management industry as a whole, generally in indirect and often subtle ways. Moreover, many of the more controversial issues under consideration during the legislative process were left to be resolved by regulatory studies and rulemakings, and in some cases further remedial legislation, deferring their resolution to a future date.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Municipal Securities Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act - August 1, 2010
Financial Reform Bill Strengthens Regulation, Expands Potential Liability of Credit Rating Agencies - July 22, 2010
Congressional Overhaul of the Derivatives Market in the United States - July 21, 2010
Dodd-Frank Act Includes Immediate Change to 'Accredited Investor' Definition for Natural Persons - July 21, 2010
Originate-to-Distribute Lives on in Securitizations of Plain Vanilla Residential Mortgages: The Securitization Reform Provisions of the Dodd-Frank Act - July 21, 2010
A New Era: Depository Institutions and Their Holding Companies Face a Deluge of Regulatory Changes - July 20, 2010
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on August 2, 2010 by K&L Gates
By: Stacey H. Crawshaw-Lewis, Deanna L. S. Gregory, Carol Juang McCoog
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act includes several provisions of potential interest to participants in the municipal bond market. The Dodd-Frank Act will require registration and regulation of previously unregulated swap and other municipal advisors. The Dodd-Frank Act also addresses the composition and authority of the Municipal Securities Rulemaking Board (the “MSRB”) and funding of the Governmental Accounting Standards Board (“GASB”). Finally, the Dodd-Frank Act directs a number of studies regarding the municipal securities market, including a study to address “the advisability of the repeal or retention of” the Tower Amendment.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Financial Reform Bill Strengthens Regulation, Expands Potential Liability of Credit Rating Agencies - July 22, 2010
Congressional Overhaul of the Derivatives Market in the United States - July 21, 2010
Dodd-Frank Act Includes Immediate Change to 'Accredited Investor' Definition for Natural Persons - July 21, 2010
Originate-to-Distribute Lives on in Securitizations of Plain Vanilla Residential Mortgages: The Securitization Reform Provisions of the Dodd-Frank Act - July 21, 2010
A New Era: Depository Institutions and Their Holding Companies Face a Deluge of Regulatory Changes - July 20, 2010
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 30, 2010 by K&L Gates
By Diane E. Ambler, Mark C. Amorosi, Robert J. Zutz, Brian M. Johnson, and Andrea Ottomanelli Magovern
On July 21, 2010, the Securities and Exchange Commission proposed a new rule and rule and form amendments that would restructure the regulatory framework for payments by mutual funds for the marketing and distribution of fund shares (the “Proposal”). The Proposal, which was unanimously approved for public comment, would continue to allow the use of fund assets to pay for distribution expenses, but would implement a new approach to regulating such payments. This new approach would break out the types of asset-based distribution fees currently paid pursuant to Rule 12b-1 under the Investment Company Act of 1940 into two components—fees for marketing and services, and asset-based sales charges—both of which could be used to finance distribution-related activities.
As described in the attached Alert, the Proposal would limit fees for marketing and services to 25 basis points per year and establish cumulative limits for asset-based sales charges imposed in addition to the fees for marketing and services. The Proposal also would substantially reduce the duties placed upon fund boards with respect to the payment of asset-based distribution fees. In addition, the Proposal would require enhanced disclosure of these and other charges in transaction confirmations and would require funds to provide conforming disclosures in their registration statements, among other documents. The Proposal also includes a component that would permit, but not require, funds to establish classes of shares to sell through broker-dealers that would determine their own sales compensation, rather than simply imposing the charges described in the prospectus as required under current law.
To view the complete alert online, click here.
Posted on July 29, 2010 by K&L Gates
By Anna Paglia and Mark R. Greer
The Committee of European Securities Regulators (“CESR”) published on April 19 a report reviewing the good and poor practices on inducements (or compensation) exhibited by more than 150 regulated European investment firms (the “Report”). The Report provides firms with a benchmark against current industry practices to measure their effectiveness in complying with the rules on inducements as stated in Article 19(1) of the Markets in Financial Instruments Directive (“MiFID”), and in Article 26 of the MiFID implementing Directive 2006/73/EC (“Implementing Directive”).
To view the complete alert online, click here.
Posted on July 29, 2010 by K&L Gates
K&L Gates Webinar Recording
By Michael S. Caccese, Nicholas S. Hodge, Rebecca O'Brien Radford, George Zornada .
Program Overview
On July 21, President Obama signed into law the "Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010." The new law will require all hedge fund managers (with certain exceptions for small and mid-sized managers) to register with the Securities and Exchange Commission and will subject them to regulatory oversight both under the Investment Advisers Act and under a new systemic risk regime administered by the SEC and a new Financial Stability Oversight Council. Under an amended version of the Volcker Rule, federally insured depository institutions and financial holding companies will face strict limitations on sponsoring and investing in hedge funds. In addition, the legislation has increased the enforcement powers and budget of the SEC, which is now focused as never before on hedge funds.
If you were unable to join us for the original presentation on July 27, 2010, you may access the webinar recording and presentation materials by clicking here.
Posted on July 22, 2010 by K&L Gates
By: Edward G. Eisert, Charles R. Mills, Anthony R.G. Nolan, Lawrence B. Patent, Gordon F. Peery
On July 15, 2010, the U.S. Senate passed by a 60-39 vote the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), following earlier passage of the legislation by a 237 to 192 vote in the U.S. House of Representatives on June 30, 2010. On July 21, 2010, President Obama signed Dodd-Frank into law.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
“Originate-to-Distribute” Lives on in Securitizations of Plain Vanilla Residential Mortgages: The Securitization Reform Provisions of the Dodd-Frank Act - July 21, 2010
Dodd-Frank Act Includes Immediate Change to “Accredited Investor”
Definition for Natural Persons - July 21, 2010
A New Era: Depository Institutions and Their Holding Companies Face a Deluge of Regulatory Changes - July 20, 2010
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 21, 2010 by K&L Gates
By: Steven M. Kaplan, Sean P. Mahoney, Anthony R.G. Nolan
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) constitutes the most sweeping financial reform package since the 1930s. Title IX of the Dodd-Frank Act (“Title IX”), entitled the “Investor Protection and Securities Reform Act of 2010” enacts a grab bag of substantial changes to capital markets regulation and practices in the hope of putting back in their bottles the twin genies of moral hazard and lax regulation that are widely viewed as the tinder that sparked the great credit conflagration of 2008. Subtitle D of Title IX, entitled “Improvements to the Asset-Backed Securitization Process” (“Subtitle D”), has been of particular interest to capital markets participants both because practices in securitization markets are widely credited with contributing uniquely to the credit crisis and because of the sense of many that the resuscitation of robust securitization markets is one of the key predicates to an economic recovery.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Dodd-Frank Act Includes Immediate Change to “Accredited Investor”
Definition for Natural Persons - July 21, 2010
A New Era: Depository Institutions and Their Holding Companies Face a Deluge of Regulatory Changes - July 20, 2010
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 21, 2010 by K&L Gates
By: Kristy T. Harlan, Vincent J. Pisano
On July 21, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Among the many provisions of the Dodd-Frank Act is a change to the definition of "accredited investor" under the Securities Act of 1933, which takes effect immediately and may impact issuers currently engaged in private offerings.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
A New Era: Depository Institutions and Their Holding Companies Face a Deluge of Regulatory Changes - July 20, 2010
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 20, 2010 by K&L Gates
By: Rebecca H. Laird, Sean P. Mahoney, Collins R. Clark
On June 30, 2010, the U.S. House of Representatives adopted the conference report on H.R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act" or "Act"), which restructures the regulatory framework for most banking organizations. The U.S. Senate followed suit on July 15, 2010. The Act is expected to be signed into law shortly. Although the full impact of the Dodd-Frank Act cannot be assessed until implementing regulations are released, depository institutions and their affiliates face new regulators, increased activities restrictions and capital requirements, and numerous other fundamental changes in how they are regulated.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
HVCC's Sunset and Other Appraisal Reforms on the Horizon - July 19, 2010
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 19, 2010 by K&L Gates
By: Nanci L. Weissgold, Kerri M. Smith
Congress is poised to eliminate the contentious Home Valuation Code of Conduct, (the “HVCC”), and with the HVCC set to sunset, more expansive (and expensive) appraisal reforms are on the horizon. Tucked within the massive Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) are provisions that will strengthen appraiser independence and enforcement, regulate the use of broker price opinions (“BPOs”), set standards for pricing of appraisals and appraiser valuation model products (“AVMs”), and subject appraisal management companies (“AMCs”) to potential federal and state oversight.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
The Resolution of Systemically Important Nonbank Financial Companies… Will It Work? - July 16, 2010
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 16, 2010 by K&L Gates
By: Stanley V. Ragalevsky, Sarah J. Ricardi
One of the glaring problems exposed by the recent financial crisis has been the absence of supervisory authority to deal effectively with the insolvency or collapse of significant, nonbank financial companies. While bank regulators have long been empowered to close and liquidate insolvent banks to protect the public, there was no comparable authority vested in any financial services regulator to close and liquidate insolvent bank holding companies or other kinds of financial companies. To make matters worse, when several systemically important financial companies were on the verge of collapse in September 2008, they were deemed “too big to fail” and given significant government assistance. Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) addresses the absence of regulatory authority to liquidate systemically important, nonbank financial companies by creating an “orderly liquidation authority” (“OLA”) process to allow the Treasury Secretary to close and the Federal Deposit Insurance Corporation (“FDIC”) to wind up these companies.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Loan Servicing Déjà Vu - July 14, 2010
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 14, 2010 by K&L Gates
By: Jonathan D. Jaffe, Steven M. Kaplan, Kerri M. Smith
This alert addresses mortgage loan servicing requirements contained in the Mortgage Reform and Anti-Predatory Lending Act (Title XIV of the Dodd-Frank Wall Street Reform and Consumer Protection Act). The Act includes restrictions and requirements imposed on loan servicers regarding qualified written requests, escrow accounts, force placed insurance, periodic statements, crediting of payments, payoff statements, HAMP requirements, and tenant protections following foreclosure, but in many cases these changes piggyback the regulations issued by the Federal Reserve Board in 2008. Nevertheless, these changes could have a material impact on loan servicers and open them up to a federal cause of action with a private right of enforcement.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Financial Regulatory Reform Increases Federal Involvement in Insurance - July 13, 2010
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 13, 2010 by K&L Gates
By: Diane E. Ambler, András P. Teleki, Collins R. Clark
Two provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173) specifically target the insurance industry and are intended to promote a higher level of uniformity in the U.S. insurance industry regulatory landscape. First, the Federal Insurance Office Act of 2010 (“FIO Act”) creates a new Federal Insurance Office (“FIO”) within the Department of the Treasury and signals the beginning of a new era of federal involvement, at least at the macro level, in the U.S. insurance industry. Significantly, the FIO Act does not include a federal insurance charter provision, long sought by many in the insurance industry, and the states will remain the primary insurance regulatory authority. Second, the Nonadmitted and Reinsurance Reform Act of 2010 (“NRRA”) changes how authority over some forms of insurance is allocated among the states.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Preemption for National Banks and Federal Thrifts After Dodd-Frank: Answers to the Ten Most Asked Questions - July 9, 2010
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 9, 2010 by K&L Gates
By: David L. Beam
The last ten years have been a period of consistent expansion of federal preemption for national banks and federal thrifts. That period of expansion will come to a grinding halt if the Senate passes and President Obama signs the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”), which most observers expect to happen shortly after the Senators return from recess on July 12.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform that are being prepared by K&L Gates. Below is a list of other alerts in the series that have already been published:
Increased Regulation of U.S. and Non-U.S. Private Fund Advisers Under the Dodd-Frank Act - July 9, 2010
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 9, 2010 by K&L Gates
By: Edward G. Eisert, Rebecca H. Laird, Cary J. Meer, Mark D. Perlow
The authors acknowledge the assistance of associates Megan Munafo and Jarrod Melson in the preparation of this Alert.
The long-awaited financial reform bill, now entitled The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Bill”), appears to be moving toward passage by the Senate and enactment into law later this month. This Alert provides an overview of those provisions of the Dodd-Frank Bill that are likely to most directly affect investment advisers to hedge, private equity and venture capital funds, wherever such advisers and funds are domiciled.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform that are being prepared by K&L Gates. Below is a list of other alerts in the series that have already been published:
Hope You Like Plain Vanilla! Mortgage Reform and Anti-Predatory Lending Act (Title XIV) - July 8, 2010
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 8, 2010 by K&L Gates
By: Kristie D. Kully, Laurence E. Platt
The Mortgage Reform Act and Anti-Predatory Lending Act, part of the comprehensive Dodd-Frank Wall Street Reform package under final Hill consideration, will likely melt any hopes for other than plain vanilla residential mortgage loans. Makers of "strawberry" or "rocky road" loans will likely face enhanced scrutiny, and may face increased damages, extended exposure to borrower claims, and risk retention requirements. In this client alert, we summarize the hefty provisions in the Mortgage Reform Act that would require creditors to consider a borrower’s ability to repay; the safe harbor for plain vanilla loans; the restructuring of mortgage originator compensation; and other amendments to TILA, HOEPA, FCRA, HMDA, and the S.A.F.E. Act. In the end, as consumers, the industry, and the federal regulatory agencies work to implement these changes, Supreme Court Justice Breyer may be the final authority on plain vanilla mortgages and the Mortgage Reform Act’s other ambiguous provisions.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Consumer Financial Services Industry, Meet Your New Regulator - July 7, 2010
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 7, 2010 by K&L Gates
By: Melanie H. Brody, Stephanie C. Robinson
The centerpiece of the Dodd-Frank Act from a consumer protection standpoint is Title X, the Consumer Financial Protection Act of 2010. The Act will create a powerful consumer financial protection watchdog, the Bureau of Consumer Financial Protection. The majority of existing federal consumer financial protection laws will come under the Bureau's purview, and the Bureau will have broad authority to enforce those laws and to issue its own rules under the Act. This alert describes the Bureau, including its structure, objectives, functions, jurisdiction, rulemaking authority and enforcement powers.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
New Executive Compensation and Governance Requirements in Financial Reform Legislation - July 7, 2010
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 7, 2010 by K&L Gates
By: James E. Earle
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), while delayed as the Senate leadership searches for votes, is almost certain nevertheless to be enacted in mid-July 2010. While the Act’s primary purpose is to broadly reform the regulation of the financial services industry, within the massive text of the Act lurk new requirements that may impact executive compensation and corporate governance practices at most public companies, not just banks. This alert highlights these key executive compensation and governance changes.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Financial Regulatory Reform - The Next Chapter: Unprecedented Rulemaking and Congressional Activity - July 7, 2010
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on July 7, 2010 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Karishma Shah Page, Collins R. Clark, Margo A. Dey, Akilah Green, Justin D. Holman
On June 30, 2010, the House adopted the conference report on H.R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Bill” or “Bill”). The Senate is expected to follow suit when it returns from recess later in July. This alert provides a high-level summary and analysis of the significant aspects of the Bill. In the days ahead, K&L Gates will be issuing alerts addressing in detail the various provisions of the Bill.
To view the complete alert online, click here.
This client alert is part of a series of alerts focused on monitoring financial regulatory reform. Below is a list of other alerts in the series:
Investor Protection Provisions of Dodd-Frank - July 1, 2010
Senate Financial Reform Bill Would Dramatically Step Up Regulation of U.S. and Non-U.S. Private Fund Advisers - June 8, 2010
Approaching the Home Stretch: Senate Passes “Restoring American Financial Stability Act of 2010” - June 8, 2010
Posted on June 25, 2010 by K&L Gates
By: Philip J. Morgan and Neil Nick Robson
On 22 June 2010, the UK's new Chancellor of the Exchequer, George Osborne, delivered the new Government's “emergency” budget. Amongst a package of other measures, he announced a bank levy from 1 January 2011, and plans to carry out further work to tackle unacceptable bank bonuses, including a consideration of the costs and benefits of a “Financial Activities Tax” on bank profits and remuneration.
Continue Reading...
Posted on June 17, 2010 by K&L Gates
By: Philip J. Morgan and Nicholas Brown
UK Chancellor of the Exchequer George Osborne yesterday announced the scrapping of the Financial Services Authority as part of a major shake-up of the regulation of financial services in the UK.
The FSA will be replaced by three new entities:
- a prudential regulator, which will be a subsidiary of the Bank of England, and will be responsible for oversight of UK-based retail lenders, investment banks, building societies and insurers, and regulation of capital requirements of financial institutions;
- a Consumer Protection and Markets Authority, responsible for the protection of consumers and day-to-day policing of financial firms; and
- a financial crime agency, incorporating the current financial crime powers of the FSA, the Serious Fraud Office and the Office of Fair Trading.
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Posted on June 17, 2010 by K&L Gates
By: Lawrence B. Patent
On June 8, 2010, the Commodity Futures Trading Commission’s (“CFTC”) Division of Clearing and Intermediary Oversight (“DCIO”) issued an Advisory regarding the extent to which certain sophisticated customers located in the United States may transact in foreign security futures products (“FSFP”). The Securities and Exchange Commission (“SEC”) issued an Order on this subject about a year ago, on June 30, 2009, as described in a previous K&L Gates Alert.
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Posted on June 10, 2010 by K&L Gates
By: Edward G. Eisert, Mark D. Perlow, Megan B. Munafo
On Thursday, May 20, 2010, the Senate voted 59-39 to adopt the financial services bill now known as H.R. 4173, the “Restoring American Financial Stability Act of 2010” (the “Senate Bill”). The Senate Bill is based on the draft Chairman’s Mark released by Senate Banking Committee Chairman Chris Dodd (D-CT) on March 15, 2010, as amended by a package of technical amendments. A bipartisan Congressional conference committee has now been constituted to resolve the differences between the Senate Bill and the House bill, which has the same bill number, but is entitled “The Wall Street Reform and Consumer Protection Act of 2009,” passed by the House on December 12, 2009 (the “House Bill”). The Democratic Congressional leadership anticipates that these differences can be resolved and a final bill presented to the President for enactment into law by early July.
To view the complete alert online, click here.
Posted on June 8, 2010 by K&L Gates
On May 20, 2010, the Senate passed the “Restoring American Financial Stability Act of 2010” as amended (“Senate Bill”). Congressional leadership has indicated that conference committee proceedings will take place in June, making it likely that the legislation will be passed by the House and Senate before the July 4th Recess and signed into law by the President shortly thereafter.
To view the complete alert online, click here.
Posted on May 26, 2010 by K&L Gates
By: Vanessa C. Edwards and Philip J. Morgan
In separate votes on 17 and 18 May, the European Parliament and the Council of Ministers (the two arms of the EU legislature) adopted their respective positions on the infamous Alternative Investment Fund Managers Directive (“the Directive”). The versions approved, however, differ significantly from each other, and the discussions will now move on to the so-called “Trialogue” procedure, involving the Parliament, the Council, and the European Commission, in an attempt to arrive at a final, definitive text acceptable to all three institutions. Although the Commission is not strictly part of the legislature, the new Internal Market Commissioner, Michel Barnier, is likely to have a significant influence in negotiating the final text given the differences between the two versions. It is hoped to have the Directive agreed in July, but this is widely regarded as over-ambitious.
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Posted on March 18, 2010 by K&L Gates
On Monday, March 15, 2010, Senate Banking Committee Chairman Chris Dodd (D-CT) released a Chairman's Mark of the Restoring American Financial Stability Act of 2010. The Bill, which has been in development for months, is intended to replace the Discussion Draft previously circulated by Chairman Dodd on November 10, 2009 and is different in many respects from H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, which was passed by the House on December 12, 2009. The Senate Banking Committee is scheduled to begin marking up the legislation on March 22.
To view the complete alert online, click here.
Posted on March 16, 2010 by K&L Gates
By: Jonathan Lawrence, Stephen H. Moller, Anthony R.G. Nolan
On March 1, 2010 after many months of work, ISDA (the International Swaps and Derivatives Association) and IIFM (International Islamic Financial Market) jointly issued the first Shari’ah-compliant master agreement for over-the-counter (OTC) derivatives. Styled the “ISDA / IIFM Ta’Hawwut Master Agreement” (ta’hawwut signifies “hedging” in Arabic), the new template master agreement (the “Ta’Hawwut Agreement”) provides a framework for the expansion of derivatives activity in the Middle East, South Asia and many regions throughout the world where hedging is not currently standard practice due to ethical concerns. While based on the 2002 ISDA Master Agreement (the “2002 Master Agreement”) and with many terms familiar to participants in swap markets, the Ta’Hawwut Agreement has been developed under the guidance and approval of the IIFM Shari’ah Advisory Panel. The Ta’Hawwut Agreement is therefore expected to be used as a reference for market participants where they or their customers need to hedge risks in line with Shari’ah principles.
To view the complete alert online, click here.
Posted on March 15, 2010 by K&L Gates
By: Philip J. Morgan
The UK remains at the forefront of international efforts to regulate bank pay practices. On 10th March 2010, the UK Treasury published draft new rules that, if they remain in their current form, will require the annual public disclosure by large banks and building societies of an "executives' remuneration report." See
http://www.hm-treasury.gov.uk/fin_bill_draftregulations.htm
The new rules would, amongst other things, require the annual disclosure of the number of employees within pay bands starting at £500,000 to £1,000,000. They would only apply to a bank (including any associated company providing services to the bank) with more than 1000 employees provided that the bank (either alone or together with its corporate group members where most of the group's activities are financial services activities) also has more than £100 billion of assets on its balance sheet.
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Posted on March 12, 2010 by K&L Gates
By: Kay A. Gordon, Dr. Wilhelm Hartung, Cary J. Meer, Philip J. Morgan, Mark D. Perlow, Neil Nick Robson, Richard Guidice, Jr
Changes in the regulatory approach to the short selling of listed securities have recently been announced in both the United States (U.S.) and the European Union (EU). In the U.S., rule amendments were recently adopted by the Securities and Exchange Commission that generally restrict market participants' ability to sell short listed securities whose price has dropped by at least 10% in a single day. In the EU, a new regulatory proposal would (to the extent adopted by the EU member states) require private disclosure of net short positions above a 0.2% threshold to the applicable regulator, and public disclosure to the market of such positions above a 0.5% threshold. We summarize in this alert what these changes entail and what each will mean for market participants.
To view the complete alert online, click here.
Posted on March 9, 2010 by K&L Gates
By: Catherine S. Bardsley, Mark J. Duggan, John J. Nestico, David Pickle, William A. Schmidt, William P. Wade, Kristina M. Zanotti.
The U.S. Department of Labor (“DOL”) has issued a new proposed regulation (the “Proposal”) in the most recent installment of its ongoing efforts to implement the statutory exemption for participant advice added to ERISA and the Internal Revenue Code as part of the Pension Protection Act of 2006 (“PPA”). The Proposal, which deals solely with advice to plan participants (as opposed to plan sponsors), would replace the final regulation and related class exemption regarding participant advice that was issued in January 2009. Notably, the Proposal would cut back significantly on what would have been permitted under that regulation and class exemption, particularly as it would have applied to advice to IRAs.
To view the complete alert online, click here.
Posted on February 15, 2010 by K&L Gates
By: Mark D. Perlow and C. Dirk Peterson
On January 14, 2010, the Securities and Exchange Commission (SEC) voted to issue a concept release intended to elicit public comment on a broad range of questions relating to the efficiency and fairness of the public equity markets (the "Concept Release"). The Concept Release revisited issues that the SEC raised and addressed nearly five years ago in a comprehensive set of market, trading and reporting rules codified in Regulation NMS. Shortly after publishing the Concept Release, the SEC also published a release proposing a new risk management rule requiring firms that sponsor trading access to exchanges and alternative trading systems (ATSs) to establish (and periodically evaluate) a system of controls intended to limit potential financial exposure and to ensure compliance with relevant regulatory requirements (the "Sponsored Access Release"). These recent market-structure initiatives form part of the SEC's ongoing review of the equity markets and follow two discrete SEC rule-making initiatives from 2009 currently under consideration.
To read the complete alert online, click here.
Posted on January 29, 2010 by K&L Gates
Contacts: Diane E. Ambler, Michael J. Missal, Matt T. Morley, Mark D. Perlow
2009 brought a further transformation in the relationship between business and government. Regardless of political systems or philosophies, governments around the world became more dynamic and intrusive in response to the financial crisis.
This 2010 Annual Report, prepared by members of the K&L Gates Global Government Solutions initiative, contains concise articles that seek to forecast likely government actions and priorities regarding a broad spectrum of topics.
To view the report, click here.
Posted on January 15, 2010 by K&L Gates
By: Sean P. Mahoney
As 2010 begins, the FDIC has indicated that private equity investors will face increased challenges in making investments in failed institutions, as certain approaches to making such investments without becoming subject to onerous FDIC requirements will not be approved.
In August 2009, the FDIC issued its “Statement of Policy on Qualifications for Failed Bank Acquisitions” (the “Policy Statement,” issued August 26, 2009 and available here), which generally subjects private investors in failed institutions to, among other things, increased capital requirements at the bank level, limits on transactions with their affiliates, prohibitions on silo ownership structures, and mandatory holding periods. The Policy Statement contained exceptions to its applicability, and many investors have been structuring their transactions to take advantage of these exceptions.
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Posted on January 15, 2010 by K&L Gates
By Sean P. Mahoney and Anthony R. G. Nolan
A possible rule change being considered by the Federal Deposit Insurance Corporation (“FDIC”) may make it difficult for banks and other securitization market participants to manage risks associated with FDIC conservatorship or receivership of sponsoring banks. This troubling development warrants attention not only from banks, but also from other participants in bank securitization transactions including servicers, rating agencies, law firms and auditors.
To view the complete alert online, click here.
Posted on January 6, 2010 by K&L Gates
By: Anna Paglia and Paul de Cordova
Effective Sunday, January 3, 2010, foreign financial institutions are authorized to establish representative offices in Dubai (see our client alert dated December 17, 2009, available here).
In response to several requests for information that the Dubai Financial Services Authority (“DFSA”) received in connection with the new regime, on December 24, 2009, the DFSA published a Q&A document addressing several operational issues affecting representative offices.
To view the complete alert online, click here.
Posted on December 22, 2009 by K&L Gates
By: Phillip J. Kardis II, Vincent J. Pisano, Douglas J. Ellis
On December 16, 2009, the Securities and Exchange Commission (the “SEC”) adopted amendments (the “Amendments”) to its executive compensation and corporate governance disclosure requirements. The Amendments are effective on February 28, 2010. Accordingly, many public companies face significant new disclosure requirements for the 2010 proxy season.
To view the complete alert online, click here.
Posted on December 21, 2009 by K&L Gates
By: Jonathan Lawrence, Philip J. Morgan, and Neil Nick Robson
The recent announcements from Dubai have turned the spotlight onto Islamic investments. The attached client alert assesses the structure, enforceability, risks and valuation issues specifically associated with the Dubai Nakheel sukuk bond and the increased uncertainty regarding the legal structures and insolvency regimes underpinning Islamic investment structures in the region. Even though the Government of Abu Dhabi and the UAE Central Bank have recently bailed out the real estate development company Nakheel and its parent company, Dubai World, there is no guarantee that they will do so again in the future. As a result of these factors, investment managers should consider examining all their Islamic investments, particularly those connected to Dubai, and working with valuation firms to determine how to approach the valuation of such investments.
To view the complete alert online, click here.
Posted on December 18, 2009 by K&L Gates
By: Richard A. Kirby and R. James Mitchell
On December 9, 2009, almost one year to the day that Bernard L. Madoff was revealed to have perpetrated the largest Ponzi scheme in history, the SEC revealed its position with respect to the approach that it believes the Securities Investor Protection Corporation (“SIPC”) should take in defining the net equity of Madoff claimants.
The SIPC Trustee has previously taken the position that net equity for Madoff’s victims should be measured on a cash-in/cash-out basis, rather than using the stated values on account statements fabricated by Madoff. This measure of net equity rejects all claims filed by victims whose net withdrawals equaled or exceeded their principal investments.
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Posted on December 17, 2009 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Karishma Shah Page, Collins R. Clark, Justin D. Holman
On December 11, the House of Representatives passed H.R. 4173, the “Wall Street Reform and Consumer Protection Act of 2009,” by a vote of 223 to 203. 27 Democrats voted against the bill and no Republicans voted in favor of the bill.
To view the complete alert online, click here.
Posted on December 16, 2009 by K&L Gates
By: David L. Beam
One of the most controversial subjects in banking law over the past decade has been federal preemption of state laws for federally-chartered banks (i.e., national banks and federal thrifts) and their operating subsidiaries. Under current law, regulations issued by the Office of the Comptroller of the Currency (“OCC”) and the Office of Thrift Supervision (“OTS”) preempt almost all state consumer protection laws for national banks and federal thrifts, respectively. When a federal law “preempts” a state law for an institution, it effectively exempts that institution from having to comply with the state law. This preemption has also been extended to operating subsidiaries of national banks and federal thrifts as well as (in certain situations) agents and other third parties acting on behalf of those institutions.
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Posted on December 11, 2009 by K&L Gates
By: Neal R. Brendel, Roberta D. Anderson
The recent announcement by the government of Dubai that it would be seeking a stand-still on debt repayments by Dubai World, and its subsidiary, Nakheel PJSC, has shaken the global financial markets and investment community. In the immediate wake of Dubai's announcement, creditors have begun to review their rights under UAE federal insolvency law and the law of other potentially applicable jurisdictions, as well as examining other available options for minimizing the financial impact of Dubai's credit crisis. This Alert is designed to assist companies by providing a general overview of the applicable insurance coverages that may cover such losses and discussing considerations for developing a plan to pursue potential insurance recovery.
To read the complete alert online, click here.
Posted on December 10, 2009 by K&L Gates
By: David H. Jones and Andrew V. Petersen
It was no ordinary day. On 25 November 2009, the Dubai government announced through its Supreme Fiscal Committee (SFC) that its Dubai Financial Support Fund (DFSF) would spearhead the restructuring of Dubai World’s financial obligations. The resulting tsunami sent shockwaves through the world markets, as it raised doubts over the Gulf Emirate's ability to meet its financial obligations. Investors with interests in Dubai and its debt market were exposed. Or were they?
As the dust settled, it became clear that Dubai World was seeking to restructure just $26 billion (€17bn, £16bn) out of a total debt of $60 billion. As a first step in the restructuring process, Dubai World and its subsidiaries, Nakheel PJSC (“Nakheel”) and Limitless LLC (“Limitless”), the real estate developer and investor famous for projects such as the spectacular Palm Jumeirah, requested their creditors agree to a “standstill” on repayments and an extension of a near-term maturity until at least 30 May 2010. The most urgent problem facing Dubai World is a $3.52 billion sukuk (the world’s biggest), an Islamic financial instrument, issued by Nakheel, and maturing on 14 December 2009 along with its two other outstanding sukuk, with a par value of $1.75 billion. To complicate matters further, the sukuk is guaranteed by Dubai World. With this requested restructuring, the legal system of the United Arab Emirates ("UAE") faced an unprecedented test. This Alert provides an overview of what this development means to those with exposure to Dubai World and Nakheel debt, by examining the applicable Islamic financing concepts and the regional legal uncertainty, the question of what creditors should do as well as outlining possible implications for investors and buyers interested in taking advantage of the opportunities that may arise.
To read the complete alert online, click here.
Posted on December 3, 2009 by K&L Gates
By: Paul de Cordova, Jeffrey N. Rich, Tony Griffiths, Dr. Sabine Konrad
The recent announcement by the government of Dubai that it would be seeking a stand-still on debt repayments by Dubai World and its subsidiary Nakheel PJSC has sent shock waves around the globe and raises questions regarding the rights of creditors in the UAE. This Alert highlights some key features of UAE federal insolvency law which may be relevant to those who have dealings with debtors in the UAE.
To view the complete alert online, click here.
Posted on December 3, 2009 by K&L Gates
Matt T. Morley, Richard A. Kirby, and Andrew Edwin Porter
The Obama Administration has recently announced the formation of a task force designed to coordinate federal, state and local efforts to investigate and prosecute fraud and other financial misconduct. The Financial Fraud Enforcement Task Force (FFETF) expands and supplants an earlier task force created to combat corporate fraud in the wake of the Enron scandal.
While the simple reconstitution of a task force is unlikely to dramatically alter the law enforcement landscape, this development may be one part of a more sweeping set of changes that could result in considerable increases in the magnitude, focus and efficiency of efforts to pursue financial wrongdoing.
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Posted on December 2, 2009 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Karishma Shah Page, Collins R. Clark, Justin D. Holman
On December 2, the House Financial Services Committee passed final bills comprising the House version of the financial regulatory reform legislation. House Floor consideration is expected as early as the week of December 7. The Senate Banking Committee is also expected to begin marking up the discussion draft of the “Restoring American Financial Stability Act of 2009” the week of December 7.
To view the complete alert online, click here.
Posted on November 20, 2009 by K&L Gates
By: Edward G. Eisert and Carolyn A. Jayne
I. Introduction.
On November 10, 2009, Senate Banking Committee Chairman Christopher Dodd introduced his discussion draft of the "Restoring American Financial Stability Act of 2009” (“RAFSA”). This draft of more than 1,100 pages in length consolidates the various components of the Administration’s regulatory reform proposals. Set forth below is an overview of those provisions of RAFSA that most directly affect investment advisers to funds that rely upon the exemptions from registration set forth in Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act of 1940 (collectively, “Private Funds”) and that materially differ from the provisions of HR 3818, the “Private Fund Investment Advisers Registration Act of 2009,” which would require certain private fund managers to register with and be regulated by the SEC, and HR 3817, the “Investor Protection Act of 2009,” passed by the House Financial Services Committee on October 27, 2009 and November 4, 2009, respectively. (For more information about the RAFSA in general, see K&L Gates alert Senator Dodd Releases Financial Reform Proposal: The Restoring American Financial Stability Act of 2009. For a discussion of the Obama Administration’s proposed legislation, see K&L Gates alert The Obama Administration’s Proposal for the Registration of Investment Advisers to Private Investment Funds: The Private Fund Investment Advisers Registration Act of 2009.)
A. Title IV of RAFSA - “Regulation of Advisers to Hedge Funds and Others.”
Private Equity Funds. Title IV provides a new exemption from registration for advisers to “Private Equity Funds,” a term to be defined by the SEC within six months after the enactment of the Act. Within the same time frame, the SEC also will be required to issue final rules regarding records to be maintained by such advisers and reports to be provided by such advisers to the SEC.
Venture Capital Funds and Family Offices. In addition, Title IV: (i) provides an exemption from registration for advisers to “Venture Capital Funds,” a term to be defined by the SEC within six months after the enactment of RAFSA; and (ii) provides a new exclusion from the definition of “investment adviser” under the Investment Advisers Act of 1940 (the “Advisers Act”) for a “Family Office,” a term to be defined by the SEC. Title IV does not include an exemption for midsized private funds (i.e., funds that have “assets under management in the United States of less than $150,000,000”) and does not impose any recordkeeping and reporting obligations on Venture Capital Funds as does HR 3818.
Financial Thresholds for Registration of an Adviser Under the Advisers Act and for an Accredited Investor. Also, RAFSA raises to $100 million the threshold for non-exempted investment advisers to be required to register with the SEC.
Title IV directs the SEC to increase the “financial threshold for an accredited investor,” as defined in Regulation D under the Securities Act of 1933, as amended, in an amount determined to be “appropriate and in the public interest, in light of price inflation . . .” and to adjust such threshold no less frequently than once every five years to “reflect the percentage increase in the cost of living.”
Independent Custodian. Title IV authorizes the SEC to promulgate rules requiring registered investment advisers to use an independent custodian to hold client assets.
Reports and Records. Title IV excludes a provision in HR 3818 requiring registered investment advisers to provide reports, records and other documents to “investors, prospective investors, counterparties, and creditors” as the SEC may prescribe as “necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.” At the same time, Title IV increases the required information to be filed in such records or reports to include valuation methodologies of the fund, types of assets held and side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors. However, off-balance sheet leverage, required to be filed with the SEC under HR 3818, is not required to be filed under Title IV. Title IV requires the SEC to report annually to Congress regarding how it has used the data collected thereunder “to monitor the markets for the protection of investors and the integrity of the markets.” Title IV also contemplates an agreement of confidentiality when information is provided to Congress.
Studies and Reports to Congress. Lastly, Title IV directs the Comptroller General of the United States to conduct studies and submit reports to Congress on three subjects: (i) the appropriate criteria for determining financial thresholds or other criteria needed to qualify as an “accredited investor” and eligibility to invest in “hedge funds (within one year of the enactment of RAFSA)”; (ii) the feasibility of forming a self-regulatory organization to oversee “hedge funds, private equity funds, and venture capital funds (within one year of the enactment of RAFSA)”; and (iii) the state of short selling in the stock market, with particular attention to the impact of recent rule changes and the incidence of the failure to deliver shares sold short (within two years of the enactment of RAFSA).
B. Title IX of RAFSA - “Investor Protections and Improvements to the Regulation of Securities.”
Fiduciary Standards of Broker-Dealers Providing Investment Advice. Title IX takes a different approach than HR 3817, the “Investor Protection Act,” to the issue presented by investment advisers and broker-dealers currently being subject to somewhat different duties to clients. As amended, HR 3817 provides that brokers, dealers, and advisers shall have the duty “to act in the best interest of the customer without regard to [compensation]” and that the standard of conduct for brokers and dealers “shall be no less stringent than” the standard for advisers under the Advisers Act. HR 3817 would retain the broker-dealer exclusion from the definition of investment adviser.
In contrast, Title IX would eliminate from the definition of “investment adviser” in the Advisers Act the categorical exception for a broker or dealer (without regard to whether any advice it provides is “incidental to the conduct of his business as a broker or dealer . . . ”). Title IX then would amend Section 206 of the Advisers Act to grant the SEC authority by rule to exempt any person or transaction, or any class of persons or transactions, from the prohibition under Section 206(3) thereof regarding principal transactions, if the SEC determines that such exemption is “for the protection of investors; and the adviser provides investors with adequate protections against conflicts of interest or principal transactions that are not in the best interests of the investors.”
Title IX also provides that “[n]othing in [Section 205 of the Advisers Act, which regulates the terms of investment advisory contracts] prohibits an investment adviser from entering into an investment advisory relationship that provides for the payment of an asset management fee or a commission.”
Lastly, Title IX would provide that it would be unlawful for an adviser “to fail to disclose to any client or prospective client any material limitation on the range of investment products about which the investment advisor gives advice . . . .”
Regulatory Oversight of Broker-Dealers. RAFSA also takes a different approach than HR 3817 to the oversight of certain advisers and broker-dealers. Currently, HR 3817 authorizes FINRA to oversee any investment adviser who has any legal or financial connection with a registered broker-dealer (although HFSC Chairman Frank has declared his intention to oppose this last-minute amendment to HR 3817 when presented to the full House). In contrast, by eliminating the exception for brokers or dealers under the definition of “investment adviser,” RAFSA appears to subject both advisers and broker-dealers to oversight by the SEC under the Advisers Act. In addition, as mentioned above, Title IV would require the Comptroller General to conduct a study of the feasibility of forming a self-regulatory organization to oversee hedge funds, private equity funds and venture capital funds.
II. Analysis.
A. The Definition of a “Hedge Fund.”
There is no statutory definition of a “hedge fund” and, as commonly used, the term “hedge funds” refers to private funds that follow a broad range of different investment strategies and employ leverage to greatly different degrees. If RAFSA is enacted in its present form, exemptions from registration will be provided to “venture capital funds” and “private equity funds” only. As a result of these provisions, and references to “hedge funds” in RAFSA, it appears that, by process of elimination, all other Private Funds might be deemed to be “hedge funds” unless the SEC also defines that term. Because of blurring of the lines between the hedge fund, private equity fund and other private fund industries, it is likely that the SEC will have difficulty in defining these terms and, accordingly, there is the not insignificant risk that the SEC will err on the side of overinclusiveness in requiring adviser registration.
B. Expanded Jurisdiction of State Regulation of Advisers.
If enacted in its present form, investment advisers that do not advise Venture Capital Funds or Private Equity Funds, would not come within one of the other narrow exemptions from registration under the Advisers Act, and have assets under management of less than $100 million would not be eligible to register with the SEC. Such advisers would be subject to regulation under the laws of the states in which they do business and, consequently, if they do business in more than one state might incur increased costs and be subject to increased regulatory burdens.
C. Treatment of Non-U.S. Domiciled Private Funds and Advisers.
Although much of the exemption provided for “foreign private advisers” is identical in both RAFSA and HR 3818, RAFSA includes one key revision to the definition of “foreign private adviser.” HR 3818 provides that a foreign private adviser must have fewer than 15 clients in the U.S. “during the preceding 12 months.” RAFSA provides no time frame for such calculation. Theoretically, non-U.S. domiciled advisers would be unable to rely upon this exemption under RAFSA after they have an aggregate of 15 U.S. clients over an unlimited period of time, regardless of whether such clients remain active clients.
RAFSA also modifies the definition of “Private Fund” in a manner that potentially is beneficial to U.S. and non-U.S. domiciled advisers to certain non-U.S. funds. RAFSA defines a “Private Fund” to be a fund that relies upon either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 and “either - (i) is organized or otherwise created under the laws of the United States or of a State; or (ii) has 10 percent or more of its outstanding securities owned by U.S. persons.” HR 3818 defines “Private Fund” to be any fund that relies upon either of those exemptions. Thus, RAFSA provides a limited exception from the definition of “Private Fund” for a fund organized in a non-U.S. jurisdiction if only a small percentage of its interests is held by “United States persons.”
Under RAFSA, non-U.S. domiciled advisers also would benefit to the same extent as U.S. domiciled advisers from the new exemptions from registration for advisers to “venture capital funds” and “private equity funds.”
Posted on November 19, 2009 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Karishma Shah Page, Collins R. Clark, Justin D. Holman
On November 10, 2009, Senate Banking Committee Chairman Christopher Dodd (D-CT) released a discussion draft of the "Restoring American Financial Stability Act of 2009." Chairman Dodd has been developing the Senate version of the regulatory reform package over several months. Until recently, the Chairman was working in conjunction with Ranking Member Richard Shelby (R-AL). However, Chairman Dodd recently decided to proceed only with the Democrats on the Committee.
At the time of this writing, the House Financial Services Committee is completing its markup of the House regulatory reform package. With the Senate and House taking different approaches in several respects, debate on significant aspects of the regulatory reform package will continue.
To view the complete alert online, click here.
Posted on November 11, 2009 by K&L Gates
By: Daniel F. C. Crowley, Bruce J. Heiman, Karishma Shah Page, Collins R. Clark, Justin D. Holman
Over the past several weeks, Congress has accelerated the financial regulatory reform effort, which will dramatically restructure the legislative and regulatory framework that governs the financial services industry. Late last week, House Financial Services Committee Chairman Barney Frank (D-MA) announced that the Committee will complete its markup of the financial regulatory reform bills by November 20.
As the House approaches Floor consideration of the regulatory reform package, the Senate is getting underway with its parallel effort. On November 10, Senate Banking Committee Chairman Chris Dodd (D-CT), who until recently had been working in conjunction with Ranking Member Richard Shelby (R-GA), released a discussion draft in the form of a single large bill.
To view the complete alert online, click here.
Posted on November 10, 2009 by K&L Gates
By: Lawrence B. Patent, Mary C. Moynihan
On October 16, 2009, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued “A Joint Report of the SEC and the CFTC on Harmonization of Regulation” (Report). The Report was issued in response to a request in the Administration White Paper on Financial Regulatory Reform.
The Report contains 20 recommendations. This Alert will focus upon the recommendations in the Report that may be of greatest interest to investment advisers: (1) the potential “uniform” standards of “fiduciary” duties for persons providing investment and commodity trading advice for securities and futures; (2) aiding and abetting liability under the Securities Act and the Investment Company Act; and (3) aligning the reporting requirements for private funds. The Alert also discusses the other recommendations, some of which may indicate enhanced opportunities for portfolio margining across markets and the prospect of greater clarity and expedited judicial review of new products that straddle jurisdictional lines.
To view the complete alert online, click here.
Posted on November 9, 2009 by K&L Gates
By: Stephen J. Crimmins, Nicholas S. Hodge, Melissa S. Holmes, Thomas F. Joyce, Beth R. Kramer, Richard A. Kirby, Mary C. Moynihan, Megan B. Munafo, Gwendolyn A. Williamson, Roger S. Wise
The Fall 2009 Edition of K&L Gates' Investment Management newsletter is offered as a timely aid in addressing the myriad regulatory issues confronting the investment management industry. Watch for future issues discussing up-to-the-minute developments and trends in the industry.
To view the complete newsletter, please click here.
Posted on October 13, 2009 by K&L Gates
By: Benoit N. Jacqmotte and Mark D. Perlow
On September 29 and 30, 2009, the Securities and Exchange Commission (SEC) held a roundtable on securities lending and short sales. On the first day, four panels of investor and industry representatives provided an overview of the securities lending market and discussed investor protection concerns, potential improvements to securities lending, and potential regulatory action in the area. On the second day, two panels addressed possible short sale pre-borrow requirements and additional short sale disclosure. This summary addresses the first-day roundtable on securities lending.
In a securities lending arrangement, the owner of securities lends out securities to market participants in exchange for a fee, upon posting of collateral (both of which, in the United States, usually take the form of cash). An institutional investor such as a mutual or pension fund will typically engage a custodial bank or other lending agent to handle the lending of securities to brokers and reinvestment of the collateral. Brokers borrow securities for a number of reasons, including for delivery of timely trade settlements and to lend to clients seeking to enter into short sales. In a short sale, a security is borrowed and sold in the market with the expectation that the security will be purchased later at a lower price (and returned to the lender), allowing the short seller to pocket the difference.
The commissioners and panelists generally agreed that securities lending is a critical component of proper market functioning because, among other reasons, such lending creates greater liquidity and enhances the ability to effect short sales (which in turn permit greater price discovery). With the intense scrutiny of short sales during the financial crisis and large losses suffered by certain institutional investors in their securities lending programs, the SEC has decided to shed light on and explore possible regulation in what SEC Chairman Mary Schapiro has called an “opaque” market.
Panel discussion focused on transaction price transparency, fee splits, cash reinvestment, proxy voting issues, the possible use of central counterparties and possible regulation. In general, while securities lending-related pricing information is available from various services, the price terms of loans tend to be individually negotiated between lending agents and brokers and depend in part on depth of information available to such parties. SEC staff members have previously expressed concern about the lack of transparency in both pricing and the supply of securities available for lending.
Net prices for borrowing securities are typically negotiated between parties and can range widely depending on such negotiations and market forces. For easy-to-borrow and highly liquid securities, lenders typically “rebate” to borrowers a substantial portion of the return they earn from reinvesting the cash collateral posted by a borrower. For hard-to-borrow securities, lenders can obtain a “negative rebate” from borrowers, in which borrowers must pay lenders a substantial rate of interest on the cash collateral for the right to borrow the relevant securities. This means that the effective cost of borrowing securities can range from a few basis points for easy-to-borrow securities to 20% and higher for hard-to-borrow securities.
Fee split arrangements between lenders and agents, under which an agent generally takes 10 to 50% of the net fees earned by a lender under its securities lending program, and the indemnification, termination and other provisions of these arrangements, appear to depend on the leverage and sophistication of the parties. Under these arrangements, securities lenders frequently delegate to their lending agents the task of reinvesting their cash collateral, usually pursuant to written guidelines in which the agent usually disclaims that it is acting as an investment adviser or manager. Given the fee splits between a lender and agent, an agent has an incentive to manage the reinvestment to yield the highest returns. Before the financial crisis, some agents reinvested securities lending cash collateral in instruments, for example in the securities of structured investment vehicles (or SIVs), that suffered from illiquidity and substantial losses during the financial crisis. Some lenders were unable to return collateral to borrowers who had returned loaned securities, and the decline in the value of these lenders’ cash collateral had to be marked to market, causing net asset value declines for these lenders.
These lenders, who had traditionally viewed the reinvestment of cash collateral as a low-risk business for a small reward, were caught flat-footed with substantial losses and liabilities. Some panelists suggested that such lenders placed undue reliance on their agents to make investment decisions or may not have fully understood the risks involved with these reinvestment programs. According to some panelists, while mutual funds tended to have the capacity and staff sophistication to “shop” among and negotiate these terms with different agents, other lenders, including smaller pension funds, did not have the capacity and expertise to negotiate in the same manner and may have been more susceptible to losses and liabilities under these arrangements. These panelists urged the SEC to consider requiring agents to make greater disclosures to all lenders regarding the range of instruments in which cash collateral may be reinvested and the risks inherent in such programs.
Panelists discussed the potential use of non-cash collateral in the securities lending process, noting that the posting of certain securities as collateral for the borrowing of securities is widely used in Europe. Some panelists suggested that the buildup of cash balances in securities lenders’ accounts caused volatility in lenders’ portfolios because the reinvestment of this collateral drove earnings during good economic periods and led to losses during bad periods. However, other panelists cautioned that while the use of other securities as collateral for securities lending (including short-term government debt securities) could mitigate some of these risks, the use of securities as collateral could introduce other risks, including correlation (or lack thereof) between the market risk of the collateral and that of underlying loaned securities.
Under securities lending arrangements, the borrower of securities generally becomes the record owner of the securities for proxy voting purposes if it owns the securities on the relevant record date. The interests of the short seller may not be aligned with those of the “long” holders of a company’s securities, including the lender: for instance, the short seller might want to vote against accepting a tender offer at a premium to the market price, since the offer would drive up the stock’s price and cause a loss in value in the seller’s short position.
Panelists discussed the record-keeping, conflicts of interests and other issues surrounding such proxy voting issues. Some panelists urged securities lenders to pay more attention to proxy voting to make sure they are able to maintain voting rights, by recalling loaned securities or otherwise, to give input on corporate action in line with their interests as “long” holders. Panelists representing both lenders and broker-dealers agreed that lenders appeared to face no difficulties or adverse consequences from recalling their loaned securities, such as being penalized by broker-dealers by losing future securities lending opportunities, and that lenders could address many of these issues by considering their proxy voting and related goals and adopting policies and procedures to give them effect.
Panelists also considered whether there should be central counterparties for securities lending, both to enhance price discovery for securities lending and to address counterparty risk. Several panelists asserted that, because price discovery was available to many lenders and their agents through pricing services, and since the collateral for borrowed securities was generally made in cash in an amount exceeding the price of the relevant security, the incremental value of using central counterparties would be minimal. Other panelists stated that the expanded use of central counterparties would have a positive impact on risk management and the transparency of the pricing and liquidity of securities lending.
Several panelists also urged the SEC to crack down on unregistered finders seeking to locate securities on behalf of broker-dealers for borrowing purposes, especially from retail owners of securities. According to these panelists, retail investors were particularly susceptible to misapprehending the risks, terms and consequences of lending securities in their portfolios. Richard Ketchum, chief executive of Financial Industry Regulatory Authority, stated that the organization is considering the adoption of rules designed to require broker-dealers to better disclose to their customers the risks and consequences of securities lending.
In her closing remarks, Chairman Schapiro stressed the SEC’s commitment to review the securities lending market’s benefits and pitfalls and to assess whether changes should be made in the regulation of the market. The SEC is accepting comments regarding issues addressed in the roundtable until October 30, 2009.
Posted on October 13, 2009 by K&L Gates
By: Daniel F. C. Crowley, Karishma Shah Page and Collins R. Clark
Congress continues to move forward expeditiously on the financial services regulatory reform effort. Over the past several weeks, House Financial Services Committee Chairman Barney Frank (D-MA), in conjunction with other key committee members, has released additional legislative proposals building on the Obama Financial Regulatory Reform plan, while Senate Banking Committee Chairman Chris Dodd (D-CT) and Ranking Member Richard Shelby (R-AL) develop a separate regulatory reform package. At the same time, these Committees have kept up a remarkably ambitious hearing schedule. This update provides an overview of significant recent developments, as well as the outlook moving forward.
To view the complete alert online, click here.
Posted on October 2, 2009 by K&L Gates
By: Daniel F. C. Crowley and Karishma Shah Page
As Congress increasingly focuses its attention on the Obama Financial Regulatory Reform (FRR) plan, the biggest change of late has to do with timing. For months, most observers have expected the House Financial Services Committee to consider the Obama proposals piecemeal, with Senate consideration following House approval. Now it is clear that the House and Senate are moving forward simultaneously, but on divergent paths. House Financial Services Committee Chairman Barney Frank (D-MA) is championing and improving the Administration proposals, and plans to move legislation to the House Floor this fall in five basic pieces (Consumer Financial Protection Agency, OTC derivatives, systemic risk, National Banking Supervisor, investor protection). These pieces reflect the groupings of the various proposals as introduced by the Administration (e.g., “systemic risk” includes the Financial Services Oversight Council, Tier 1 Financial Holding Companies, and securitization). Senate Banking Committee Chairman Chris Dodd (D-CT) has his own ideas in key areas, many of which go further than the Obama plan. Chairman Dodd currently plans to bring a single, omnibus reform bill to the Senate Floor. Short updates on the major FRR provisions follow:
- The Financial Services Oversight Council (FSOC) - The FSOC is one of the simplest aspects of the FRR and therefore almost certain to occur. It is basically the successor to the current President’s Working Group on Capital Markets, with a dedicated staff at the Treasury Department and the addition of the heads of the FDIC, and the new Consumer Financial Protection Agency and the National Bank Supervisor. A key question is what role the FSOC will play with respect to systemic risk. If Chairman Dodd has his way, it will assume some of the functions contemplated for the Federal Reserve in the Obama/Frank plan.
- Tier 1 Financial Holding Companies (FHCs) - As expected, serious questions have been raised about the Fed’s capacity to provide consolidated supervision of large, integrated financial institutions. There is a growing political backlash to what some view as overreaching to position the Federal Reserve as the primary systemic risk regulator. The fact that large non-depository institutions could be regulated as Tier 1 FHCs is reminding many on the Hill that they really do not trust the Federal Reserve, and that the role of a central bank may be somewhat inconsistent with such a prominent regulatory function.
- National Bank Supervisor - As many expected, the Administration’s effort to squeeze all federally chartered financial institutions into the bank model is falling short. The thrift charter appears likely to be preserved, industrial loan companies (ILCs) grandfathered, and credit card lenders will not be deemed banks. Given the failure to close the other Bank Holding Company Act “non-bank loopholes,” many also see no reason to abolish the exception for non-depository trust companies. Nonetheless, Chairman Dodd has said the Administration proposal does not go far enough and would like to see further consolidation among the banking regulators. Chairman Frank favors preserving the dual state and federal banking systems. The outcome is uncertain.
- Securitization - This remains a four-letter word for the time being. It is currently disfavored and, certainly, the days of passing along 100% of the default risk to investors are over. In short, keeping originators’ “skin in the game” remains a primary objective of Chairman Frank and other key policy makers.
- The Consumer Financial Protection Agency (CFPA) - In the interest of co-opting business interests, Congressional Oversight Panel Chairwoman Elizabeth Warren, who first proposed the CFPA, has been thrown under the proverbial bus. Chairman Frank recently circulated an updated CFPA bill. In its current form, the bill exempts non-financial companies and jettisons requirements for “plain vanilla” products. As such, Chairman Frank has made it much harder for even some Republicans to oppose the CFPA. Indeed, banks may even conclude that subjecting their competitors (e.g., non-depository mortgage originators, payday lenders, etc.) to the same regulatory burdens they have faced for years might be worthwhile after all.
- Private Fund Investment Advisor Registration Act - As currently drafted, the Obama plan would require the registration and regulation of virtually all private fund managers, including hedge funds, private equity funds, sovereign wealth funds, and even family investment pools. Much of the alternative fund industry seems to have embraced “reform” in hopes of being favorably positioned in the rulemaking process. Alas, such a strategy failed convincingly in the context of Sarbanes-Oxley.
- Resolution authority - There has been much discussion about how to unwind systemically significant failing institutions. Chairman Frank has referred to such powers as a “death sentence.” The FDIC resolution powers regarding banks will be expanded, probably extended to Treasury, and the SEC will be given similar responsibility with regard to the regulated entities within its purview. As an aside, requiring Treasury to sign off on Federal Reserve uses of authority under FRA section 13(3) is (discount) window dressing, since Treasury is de facto fulfilling that role now.
- OTC derivatives - In the wake of AIG and its credit default swaps, there is a clear consensus around centralized clearing of all derivatives, and a majority preference for exchange trading of standardized contracts. On August 11, the Administration introduced its OTC derivatives proposal as the “final piece” of its legislative proposals. However, there are a number of competing proposals, including S. 1691, which was recently introduced by Senate Securities Subcommittee Chairman Jack Reed (D-RI). All of these proposals would provide strong regulation of all major participants in the OTC derivative markets, and would create new anti-fraud and market manipulation enforcement powers.
- Credit rating agencies - House Financial Services Capital Markets Subcommittee Chairman Paul Kanjorski (D-PA) recently circulated a discussion draft that builds on the Obama proposal to have the SEC comprehensively regulate Nationally Recognized Statistical Ratings Organizations (NRSROs), and would impose information sharing requirements, as well as “collective liability” on the entire industry for a monetary judgment against any NRSRO relating to a credit rating. It is difficult to imagine that this provision will survive, but it clearly reflects a great deal of consternation about the industry (see pp. 30-31).
- Executive compensation - Shareholder say-on-pay proxy votes and compensation committee independence are soon to become part of the ever-expanding corporate governance montage.
- Insurance - While the insurance industry appears to have escaped the CFPA, there will be a new Office of National Insurance at Treasury that will aggregate state insurance data. Together with the FSOC, and Tier 1 FHC supervision by the Fed, the insurance industry may end up wishing it had reached consensus on a federal charter. Stay tuned for more in the next Congress.
Finally, with both the House and Senate moving forward quickly, the timetable for successfully advocating changes in much of the legislation will likely be truncated. Ultimately, the differences between the House and Senate versions will be reconciled in conference committee, a process largely shielded from public scrutiny (or influence). Please see the K&L Gates alert Eye of the Storm: A Summer Recess Assessment of the Capital Markets Reform Effort for a comprehensive overview of the Obama plan. In addition, detailed analysis on many of the Obama proposals may be found on http://www.globalfinancialmarketwatch.com/.
Posted on September 29, 2009 by K&L Gates
By: Sean P. Mahoney
After a few high-profile investments in banking organizations by private equity firms, the FDIC appears to be rethinking its policies on new entrants into the banking industry. This trend is evidenced by two recent FDIC pronouncements indicating the regulator’s increased scrutiny of certain private equity acquisitions and more strict limitations on the business activities of certain newly created banks.
The FDIC’s Final Statement of Policy on Qualifications for Failed Bank Acquisitions (the “Policy Statement”) (issued August 26, 2009 and available here), relates only to acquisitions of failed banks by private equity firms, including acquisitions made through the use of a new charter from any regulator. Although the Policy Statement generally does not extend to transactions outside the context of FDIC conservatorship or receivership, it may also extend to so-called “inflatable charters” or small banks acquired to facilitate the acquisition of failed institutions. Nevertheless, it contains a number of burdensome provisions that apply only to the acquisition of failed banks by private equity firms, but not to other acquirers. These provisions include:
- a requirement to maintain the bank’s Tier 1 common equity ratio at 10% or more for three years following the acquisition;
- prohibitions on the acquired bank extending loans to any of its private equity investors or any entity in which any such investor owns 10% of the equity;
- a prohibition on silo ownership structures (e.g., structures with parallel ownership between the bank and a private equity fund); and
- a requirement that the private equity investor commit to hold its investment in the bank for three years or more.
At the same time, the Policy Statement may create artificial barriers to entry and competitive imbalances among private equity firms, as the FDIC reserved authority to exempt from the Policy Statement investors that have held investments in banks that retain one of the two highest examination ratings for a period of seven or more years. In other words, certain experienced bank investors may not be subject to the more stringent standards contained in the Policy Statement.
The FDIC also recently issued “Enhanced Supervisory Procedures for Newly Insured FDIC-Supervised Depository Institutions,” FIL-50-2009 (the “Enhanced Supervisory Procedures”) (issued August 28, 2009 and available here). The Enhanced Supervisory Procedures impose increased regulation upon investors who enter the banking industry for the first time by forming new state-chartered banks. The Enhanced Supervisory Procedures apply only to de novo FDIC-insured state banks, and not to de novo national banks or federal savings banks.
While all de novo banks are required to conduct their first three years of operations within the bounds of a business plan submitted to regulators as part of the chartering process (during which time they are subject to more frequent examinations), the Enhanced Supervisory Procedures expand that period to seven years for newly formed state banks that have the FDIC as a primary regulator.
Although the Policy Statement and Enhanced Supervisory Procedures do create new barriers, they also provide a regulator-sanctioned framework for private equity firms to bid on failed institutions. It remains to be seen whether such barriers are significant enough to deter private equity investors.
Posted on August 12, 2009 by K&L Gates
By: Diane E. Ambler, Philip M. Cedar, Daniel F. C. Crowley, Vanessa C. Edwards, Edward G. Eisert, David H. Jones, Steven M. Kaplan, Sean P. Mahoney, J. Matthew Mangan, Philip J. Morgan, Mary C. Moynihan, Anthony R.G. Nolan, Clair E. Pagnano, Lawrence B. Patent, Karishma Shah Page
Since June 17, 2009, when the Obama Administration unveiled its financial regulatory reform plan, there has been a flurry of executive branch and legislative branch activity. The frenetic pace of the reform effort is expected to resume in the fall, as Congress works to resolve the many highly controversial issues presented by the plan. The traditional August Congressional recess now underway provides an opportunity to take stock of this historic capital markets reform effort. This alert provides an overview of the most significant developments so far, as well as the outlook moving forward.
To view the complete alert online, click here.
Posted on August 11, 2009 by K&L Gates
By: Rebecca H. Laird, Edward G. Eisert, Stanley V. Ragalevsky, Sean P. Mahoney, Daniel F. C. Crowley, Collins R. Clark
On July 22 and 23, 2009, the U.S. Department of Treasury released nine legislative proposals affecting banking institutions and their holding companies. The various parts of this proposed legislation interact in a manner that, if enacted, will change the banking industry’s playing field in unprecedented ways. These changes aim to end regulatory arbitrage and minimize systemic risk.
To view the complete alert online, click here.
Posted on August 11, 2009 by K&L Gates
By: Gordon F. Peery, Lawrence B. Patent, Anthony R.G. Nolan
Activity in the U.S. House of Representatives in late July 2009 gave the financial services industry a glimpse of legislative initiatives that, if enacted into law, may dramatically transform the over-the-counter (“OTC”) derivatives market. Congress will debate the aggressive legislative initiatives detailed in this Alert soon after it reconvenes following its August recess. The initiatives go hand-in-hand with the rest of the Obama Administration’s Financial Regulatory Reform mandates. In order to understand the importance of the July 2009 initiatives, it is first necessary to briefly review industry, regulatory and legislative efforts to reform the OTC derivatives market earlier this year.
To view the complete alert online, click here.
Posted on July 27, 2009 by K&L Gates
By: Melanie Hibbs Brody, Steven M. Kaplan, David L. Beam, Stephanie C. Robinson
With the power to impose penalties of up to $1 million per day, the recently proposed Consumer Financial Protection Agency (“CFPA” or “Agency”)—an independent agency with the sole mission of protecting consumers—is the subject of much attention. After Congress returned from the Independence Day holiday, House Financial Services Committee Chairman Barney Frank introduced House Bill 3126—entitled Consumer Financial Protection Agency Act of 2009 (“bill” or “Act”). The bill mirrors draft legislation that the Obama Administration delivered to the Hill the previous week, with only a few substantive changes, and is based on the recommendations the Administration set forth in its financial regulatory reform package issued earlier this year to establish the Agency.
To read the complete alert online, click here.
Posted on June 25, 2009 by K&L Gates
By: Melanie Hibbs Brody, Stephanie C. Robinson
No one doubts that consumers have been hurt by the global financial crisis and a better federal and state regulatory regime could lessen the likelihood of future harm in the consumer credit arena. The question is how best to accomplish that objective? Is it simply a matter of better funding of the enforcement of existing laws? Is it prudent to impose new substantive obligations on providers of consumer financial products and services? Do we need to shuffle the boxes out of which regulators operate to ensure a better-coordinated approach to government regulation and enforcement?
At a press conference on June 17, 2009, President Obama laid much of the blame for the financial crisis on gaps in financial regulation. To fill in those gaps, the President unveiled his proposed financial regulatory reform package—a white paper entitled A New Foundation: Rebuilding Financial Supervision and Regulation. Among many recommendations for significant change, the reform package recommends the creation of a new federal agency with the singular job of, in the words of Mr. Obama, “looking out for consumers.” The new Consumer Financial Protection Agency (CFPA) would be designed to protect consumers in the financial products and services markets, and would be the primary federal consumer protection supervisor.
To read the complete alert online, click here.
Posted on June 4, 2009 by K&L Gates
By: Stanley V. Ragalevsky, Sean P. Mahoney
On May 20, 2009, the Office of Thrift Supervision (“OTS”) and the Federal Deposit Insurance Corporation (“FDIC”) approved the acquisition of a failed thrift institution, BankUnited, FSB, by a group of private equity investors. The FDIC, as receiver of the failed institution, accepted the private equity investors’ bid as the least cost resolution of the failure. In approving the transaction, the OTS permitted the transaction to be structured in a way that allowed the constituent members of the investor group to remain free of the regulatory restrictions that apply to those who control thrift institutions. The transaction thus offers important precedent as to how purchases of failed institutions may be accomplished by private equity firms. It also highlights significant uncertainty regarding private equity investments in commercial banks.
Historically, investors in depository institutions and their holding companies have sought to avoid investments that would be considered “controlling” under the federal banking laws. Control of a depository institution, either directly or indirectly, can lead to limitations on the activities of the controlling company, requirements to support financially the subsidiary depository institution, and also subject transactions between the depository institution and the affiliates of the controlling investor to certain restrictions. Moreover, investors deemed to have “control” of a depository institution generally must register as a bank, financial, or thrift holding company, with ongoing regulation and reporting requirements. These restrictions have discouraged investment in banks and holding companies at a time when these organizations desperately need to attract additional capital. (See also K&L Gates client alert, Non-Controlling Investments in Banking Institutions and Their Holding Companies).
In the BankUnited transaction, the investor group formed two holding companies (a top-tier and an intermediate-level entity) to acquire the bank’s shares, and the holding companies applied for regulatory approval as savings and loan holding companies, which was required to permit them to acquire control of the bank. At the same time, each of the constituent investors – none of whom had beneficial ownership of more than 25 percent of the voting securities of either the holding companies or the bank – disclaimed control of the bank by filing a Rebuttal of Control Agreement, along with a rebuttal of the presumption of control, with the OTS. Significantly, the OTS accepted the investors’ position that the investor group members were not acting in concert. By effectively determining that the act of forming an investment vehicle to acquire control of a bank was not concerted action, OTS appears to have eased the way for private equity club deals to acquire federal savings banks and state-chartered savings banks that elect to be regulated by the OTS.
In its press release announcing the resolution of the BankUnited matter, the FDIC indicated that it would publish guidance on eligibility for non-bank firms to bid on failed banks and the terms and conditions for such investments. Such guidance should prove valuable to private equity firms wishing to bid on failing banks.
Unfortunately, the structure approved in the BankUnited deal, while approved for a savings and loan holding company, may not translate to the commercial bank sector. Commercial bank holding companies are regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), which specifically declined to adopt guidance on simultaneous minority investments in depository institutions (i.e., “club” deals) in its September 22, 2008 guidance on non-controlling investments in banks. Thus, it remains unclear whether the Federal Reserve would accept, as OTS has, that investment firms could disclaim control when forming a common investment vehicle. This leaves significant uncertainty in the regulatory framework applicable to private equity investments in commercial banks. Also uncertain is the status of the so-called “silo” structure whereby individual investors in a private equity fund can invest in a bank thereby avoiding the private equity fund from taking control of the target bank. The Federal Reserve appears to disfavor the silo structure, and the Bank United order does not provide any guidance to how the OTS and FDIC view it.
Unless and until the Federal Reserve issues guidance on this issue or rules on a transaction similar to the BankUnited deal, it will remain unclear the extent to which groups of private equity firms will be able to take over and recapitalize failing commercial banks.
Posted on June 4, 2009 by K&L Gates
By: Edward G. Eisert, Megan B. Munafo
Hedge funds are under intense scrutiny as a result of the global financial crisis and the most comprehensive review of the financial industry regulatory framework in 70 years. Until recently, most legislators and regulators believed that the hedge fund regulatory regime was adequate, taking into account reliance on the oversight of hedge fund financial counterparties, such as prime brokers. However, in the current environment, anxiety has grown that hedge funds could pose a systemic risk to the global financial system due, in part, to: (i) the large amount of assets managed through hedge funds; (ii) the use of leverage by hedge funds; (iii) the relative lack of transparency concerning their operations; and (iv) the limited power of regulators to examine their managers and the funds themselves.
Although hedge funds have been a focus of regulatory reform in the past, global initiatives have accelerated in 2009. In the wake of the April 2009 G-20 meeting held in London, two sets of initiatives are anticipated to significantly reshape the regulation of hedge funds: (i) the draft Directive on Alternative Investment Fund Managers (“AIFMs”) issued by the European Commission; and (ii) legislative developments in the United States.
Draft Directive Issued by the European Commission
On April 29, 2009, the European Commission proposed legislation designed to impose the first European-wide regulation of alternative investment capital pools, including hedge funds, in an effort to reduce systemic risk and harmonize regulation in the European Union (“EU”). The proposed Directive on Alternative Investment Fund Managers (the “AIFM Directive”) would require EU-domiciled managers of hedge funds and other alternative capital pools with assets under management of more than €100 million, or €500 million where the funds have “no leverage” and a “lock-up period” of five years or more, to be “authorized” by their home Member State and report regularly on the main investments of the fund, its performance and risks. In addition, AIFMs would be subject to ongoing regulation relating to minimum capital, risk management and audit arrangements. (Directive of Alternative Investment Fund Managers (AIFMs): Frequently Asked Questions, Memo/09/211, 29/04/2009).
The AIFM Directive would not regulate the fund itself, its fees, or its investment objectives. Rather, the AIFM Directive provides that: (i) only AIFMs established in the EU can provide their services in the EU; and (ii) only funds domiciled in the EU can be marketed by authorized AIFMs in the EU. Nonetheless, in order to allow offshore funds to continue to be offered in the EU, the AIFM Directive would provide an “EU Passport” for the marketing of such funds that comply with “stringent requirements in regulations, supervision and cooperation, including on tax matters.” The AIFM Directive would impose for the first time capital requirements on AIFMs and limits on fund leverage, and it would also establish business conduct principles such as fair dealing and detailed rules regarding independent valuation and disclosures to investors and reporting to regulators. The AIFM Directive would also institute reporting requirements regarding controlling interests in fund portfolio companies. In order to allow time for the development of rules allowing for the marketing of “third country funds,” for a period of three years after the effectiveness of the AIFM Directive, third country funds could continue to be sold in the EU, subject to individual Member State approval. In light of the strong critical reaction by various organizations in the alternative investment industry, and the requirement that the AIFM Directive is subject to approval by the European Council and the European Parliament, it is not likely to become effective until at least 2011. For more information on the proposed Directive, please see the K&L Gates Alert “European Commission Proposes Regulation of Alternative Investment Fund Managers.”
U.S. Legislative Developments
In the first quarter of 2009, several bills were introduced in the U.S. Congress that would require hedge fund managers and “large” hedge funds to register with the U.S. Securities and Exchange Commission (“SEC”), comply with information reporting and other requirements, and subject them to further study. One, the “Hedge Fund Transparency Act,” would limit the availability of the exemptions from registration under the Investment Company Act of 1940 relied upon by hedge funds to those with assets under management of less than $50 million. (S. 344, 111 th Cong. (2009)). Another, the “Hedge Fund Adviser Registration Act of 2009,” would eliminate the “private adviser exemption” under the Investment Advisers Act of 1940 (the “Advisers Act”), commonly relied upon by hedge fund managers, with the effect of requiring virtually all hedge fund managers to register with the SEC under the Advisers Act. (H.R. 711, 111th Cong. (2009)). Although its precise terms have not yet been defined, following the G-20 meeting in April and the increased focus on a global systemic risk regulator, a broad legislative proposal is anticipated in 2009 that will include a requirement that private fund managers be registered under the Advisers Act. The Obama Administration has also proposed that the SEC be authorized to obtain, among other things, hedge fund portfolio holdings information from fund managers in order to report on potential systemic risks to a newly designated systemic risk regulator.
In May 2009, in testimony at a hearing held before the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, the Managed Funds Association (the “MFA”) announced its support for the mandatory registration of investment advisers (including advisers to private pools of capital) with the SEC under the Advisers Act. The MFA is an organization comprised of professionals from hedge funds, funds of funds, managed futures funds and industry service providers. The proposed framework supported by the MFA goes beyond recent proposals, which only sought to require the largest fund advisers to be registered, and would subject the vast majority of investment advisers to the registration requirements of the Advisers Act. The MFA’s position signals that leading hedge fund managers have accepted that there will be increased regulation and are trying to shape it rather than fight it.
Also of far-reaching impact, the President’s Budget Outline for fiscal year 2010 includes provisions for the taxation as ordinary income of the “incentive allocation” or “override” received by the managers of U.S.-domiciled hedge funds. As proposed, the “Stop Tax Haven Abuse Act” would “restrict the use of offshore tax havens and abusive tax shelters to inappropriately avoid federal taxation, and for other purposes.” (S. 506, 111 th Cong. (2009); H.R. 2136, 110 th Cong. (2007)). At the same time, the Treasury has reaffirmed the value of private pools of capital to the financial system in its proposals for Public-Private Investment Funds.
Moving Forward
As these various initiatives progress, it appears that not only will private investment fund managers, wherever domiciled, become subject to more intense U.S. regulatory scrutiny, but U.S.-domiciled managers will become subject to EU regulatory scrutiny, at least insofar as they manage European-based funds or market funds in Europe. An active, substantive dialogue between the private sector and global regulators will be necessary in order to promote the development of regulatory reforms that are measured and that contribute to the restoration of financial market stability without unduly restricting the ability of hedge funds to meet the needs of investors.
Posted on June 4, 2009 by K&L Gates
By: Mary C. Moynihan, Diane E. Ambler
Although mutual funds have not been implicated as a cause of the financial crisis, many investors have experienced the crisis most directly through the plummeting value of their mutual fund investments. As Washington moves to address the myriad issues arising from the crisis, the mutual fund industry should expect to see changes that will directly affect how funds—and their advisers, distributors and custodians—do business. Changes of particular interest to the mutual fund industry are discussed below.
Change to Primary Regulator for Registration of Mutual Funds, Broker-Dealers and Advisers
Lawmakers are considering several configurations for a new regulatory regime. These include consolidation of the SEC with the CFTC—although Barney Frank, the powerful chair of the House Financial Services Committee, has expressed doubts as to whether such consolidation will happen. Another idea involves the creation of a financial products safety commission. Whether that proposal will take hold is unclear, although key Democrats in the Senate and House have submitted a bill to create the commission. Even if it were created, the White House is reported to support a plan under which the new financial products safety commission would focus on consumer products such as mortgages and credit cards, but would not have jurisdiction over securities (and therefore mutual funds), which would instead be regulated by the new agency resulting from a merger of the SEC and CFTC. Because the proposals are likely to trigger a turf war in Congress and among the affected agencies, it is still too early to predict the outcome. Lawmakers are also still waiting for final proposals from the Obama administration.
Money Market Funds
Money market funds have drawn closer regulatory scrutiny since the Reserve Primary Fund broke the buck in September, spurring large-scale redemptions from money market funds with large institutional investor bases and a guarantee program from the U.S. Treasury. While the Group of 30 proposed earlier this year that funds that maintain a stable $1 NAV be regulated as special purpose banks, this proposal does not seem to have gained traction. However, a consensus has developed on the need to tighten the rules governing money market funds’ portfolio assets’ credit quality, maturity and liquidity. The first detailed proposal came in March from a task force convened by the Investment Company Institute, which included proposals to (1) impose daily and weekly minimum liquidity requirements; (2) stress test the portfolio; (3) tighten portfolio maturity limits; (4) raise credit quality standards on portfolio investments; (5) address client concentration risks; (6) disclose portfolio investments monthly; (7) require additional risk disclosures; (8) authorize suspending redemptions for several days for failing funds; and (9) establish a nonpublic reporting scheme to regulators for all money market investors. The SEC has not yet produced a detailed proposal. However, SEC Chair Mary Schapiro has made clear that the SEC will propose tougher rules later this month that will “extend beyond” the ICI task force proposals. The staff is examining the credit quality, maturity and liquidity provisions currently applicable to money market funds and considering whether more fundamental changes are needed, including floating rate net asset values for money market funds.
“Proxy Access” and “Say on Pay”
In May, the SEC proposed a new “proxy access” rule that would set a tiered system under which shareholders may nominate candidates for election to boards of directors. For example, for companies with a market cap of $700 million or more, shareholders owning at least 1% of the voting securities would be eligible to nominate directors. By some estimates, this could increase by three or four times the number of contested director elections that funds must evaluate in exercising proxies. In addition, funds themselves would be subject to the proposed rule, which would allow shareholders to nominate fund directors. Finally, funds with ownership positions in excess of the thresholds would need to determine whether they should be proposing director candidates for portfolio companies. These proposals would transform a fund’s traditional analysis of “buy vs. sell” and force new decision-making concerning voting and management. Also in May, Senators Charles Schumer and Maria Cantwell introduced a “shareholder bill of rights” that would require non-binding shareholder votes on how executives are paid. The bill is not likely to pass in its current form but, particularly in view of the action taken earlier this year by the House to limit compensation of recipients of TARP money, any reform package is likely to include some corporate governance component.
Emerging Best Practices Relating to Risk Management
Many fund advisers and boards are examining whether the events of the past year suggest that they need additional risk monitoring programs to evaluate risk elements in the portfolio and the adviser’s organization. There is no “one size fits all” answer to the risk management puzzle, and the precise actions that a fund family and its board should take with respect to risk assessment are highly subjective and based on many different factors, including the nature of the fund family’s investments, experience with risk, organizational structure, and nature of investors. Nonetheless, the SEC has indicated that risk will be a central concern, suggesting that advisers may need to develop a more robust approach to risk management and that fund boards may wish to consider creating a risk management oversight committee or adding responsibility for risk oversight to an existing committee, such as compliance or investment performance.
Target Date Funds
In a May speech to the Mutual Fund Directors Forum, SEC Chair Schapiro stated that the SEC is closely examining target date funds due to concerns with performance of the funds during the market decline. As these funds approach their “target” date, their asset allocations should move toward a more conservative allocation, often referred to as a fund's “glide path.” Some funds may have established more aggressive glide paths based on the assumption that investors would continue to maintain their investments, and partially live off the proceeds following retirement. This could be particularly problematic for a target date fund underlying a college investment plan, since those investors would need to access their investment at or near the fund’s target date. Chairman Schapiro stated that the SEC staff would be closely reviewing target date funds’ disclosure about their glide paths and asset allocations, examining whether the same target date funds underlie both retirement and college savings plans and considering whether the target dates in some funds’ names are misleading. Chairman Schapiro also challenged fund directors to review their funds’ allocations between asset classes.
Custody of Client Assets by Investment Advisers
Following the Madoff scandal, the SEC has moved swiftly to propose new rules governing the custody of client funds held by all registered investment advisers. The proposed rules would require advisers to undergo an annual surprise examination by an independent public accountant to verify client assets. In the case of assets that are not maintained by an independent qualified custodian, the rules would require a “SAS-70” report from an independent public accountant registered with and inspected by PCAOB that includes an opinion covering controls over custody of client assets. The proposed rules would not apply to custody of assets held by mutual funds, but would affect advisers with respect to other classes of client funds.
When the dust settles, the investment management landscape will undoubtedly be much changed. Mutual funds will likely be subject to new rules, regulated by a reconstituted regulator, and, especially if hedge funds and other unregulated entities face more regulation, will encounter a new competitive environment. Industry participants should closely monitor these developments and may wish to provide input into policy choices that will have direct implications for them and their investors.
Posted on June 4, 2009 by K&L Gates
By: Daniel Wise
So said Gordon Brown in the immediate aftermath of the economic crisis that shook the City in October of last year. This sentiment has been echoed by the Treasury Committee’s report published on 15 May which stated that “bonus driven remuneration structures led to a lethal combination of reckless and excessive risk taking.” As the recession begins to deepen in the UK, unemployment continues to rise and city financiers lick their wounds following a record low bonus round this year, a web of employment law issues arise out of employer reaction to this paradigm shift in the financial markets.
Primary among these are issues as to the legality of City employers’ attempts to slash bonus awards or recoup payments already received, and how to shape the bonus elements of remuneration structures in senior level service contracts to reflect changes in the expectations of both employers and employees in an environment that has grown intolerant of the fat cat/big bonus City culture.
Bonus Litigation
Hundreds of staff members at Dresdner Kleinwort have lodged claims to recover tens of millions of pounds in unpaid bonuses resulting from the decision of its new owner, Commerzbank, to slash compensation payouts. A raft of similar claims are expected against other financial institutions as employers come under increased commercial pressure to reduce or eliminate bonus payments, particularly in circumstances where organisations are now effectively Government run.
Depending on the specific employer bonus structure, the legal ramifications of trimming such bonus payments may be significant. Many employers will have established contractual obligations to certain levels of bonus payment in recent years, either through custom and practice, or as a part of negotiated service agreements to attract particular stars in the financial community. For example, many banks in recent years have introduced a “Golden Hello” scheme to new joiners, guaranteeing a minimum level of bonus for all or a portion of their first bonus year, regardless of performance during that period. These payments are designed to compensate new recruits for the bonus they have lost leaving their previous employer midway through a bonus year. A refusal to honour such a contractual provision will almost certainly be unlawful.
Another common trend that has developed in the City in recent years has been to link bonuses to performance targets, creating an irreducible contractual entitlement once these personal performance targets are hit, irrespective of the bank’s overall performance. These targets are often short term, and often paid out in lump sum cash awards. Despite the current climate and the potential difficulties banks are now facing, if such bonuses are not paid in circumstances where performance targets have been hit, again the employee is likely to have a strong claim for the recovery of this sum.
Thus where banks have bowed to commercial pressure to reduce bonuses as a result of a disastrous bonus year and a pessimistic financial forecast for 2009, the Courts may well rule against them, given the case law in recent years in favour of an employee’s contractual entitlement to certain levels of bonus payment irrespective of the economic climate and/or the strength of the particular bank’s financial position.
When addressing the restructure of bonus schemes for future years, many UK employment lawyers caution against changing too much too quickly, although in the current economic climate many financial institutions will have no choice. For example, adoption of the recent FSA Code’s principles and replacing what was previously a contractual bonus structure with deferred bonus scheme, may cause wholesale team moves to competing institutions along with a raft of constructive unfair dismissal claims from departing employees arising out of the bank’s breach of its implied duty of trust and confidence. However, the financial landscape will also be a major factor in assessing the commercial risk of these claims being brought. If either the majority of other banks are unwilling to take on new recruits or are adopting similar schemes for their employees, there will be little practicable risk of this legal consequence.
Repaying a Bonus
The clarion call through both the press and in political circles for high-profile, senior-level executives to repay bonuses which have already been awarded also throws up some interesting issues for UK employment lawyers. One individual who bowed to public pressure and repaid a substantial bonus is Michael Fingleton, chief executive of Irish Nationwide, who in March of this year voluntarily returned his €1 million bonus awarded for 2008. In his statement to the press at the time. Mr. Fingleton was at pains to point out that the bonus was “a contractual and binding agreement... which [he] was legally entitled to receive….” His move came in response to both political and commercial pressure, rather than as a consequence of any legal obligation to do so. This is of course correct. In circumstances of this kind, particularly where payment of the bonus is pursuant to a contractual entitlement, any employer’s remedies against senior executives to compel repayment are limited, unless specific contractual provision has been made for this within the service agreement. In circumstances of alleged regulatory breach by a financial institution, employers are in a much weaker position in the UK than in the US, where the Sarbanes-Oxley Act of 2002 requires certain levels of senior executives to repay incentive based remuneration in specific instances of securities law breaches.
Making provision for a contractual term forcing repayment in these circumstances is now an issue that many UK banks are grappling with. The move to include such a term is not without its difficulties.
Firstly, the UK law on penalty clauses will cause such a contractual provision to be unenforceable if it provides for repayment of a bonus as a result of a breach of contract and the repayment is deemed to be a penalty. In determining this, a Court will consider whether the payment is a genuine pre-estimate of the loss suffered by the bank arising out of the breach or simply a penalty. If it is the latter, the clause will be unenforceable. However, case law on this subject suggests that where there is a bona fide attempt to pre-estimate loss, such a clause may be upheld, despite the fact that the figures differ from the actual loss caused.
Secondly, the purpose behind the clause must be to compensate the employer rather than to act as a deterrent. It is often the case in a financial context that breach by a senior executive could lead to substantial monetary losses, and in circumstances where such losses far exceed the amount required to be repaid by the director it will be easy for the employee to suggest the repayment was not to compensate the bank, but to act as a deterrent. Whilst it is possible to put together a sliding scale of repayment which is directly linked to loss flowing from the breach, persuading a senior executive to sign up to such a clause may well be an unsurpassable hurdle to any subsequent challenge.
Thirdly, proving that the breach occurred is often a practical difficulty in consequent litigation, particularly in the context of complex financial dealing structures where a Court is asked to determine the reasonableness of a decision arrived at based on complex assessments of commercial risk. This hurdle can often make such a clause unworkable.
An alternative approach to clauses of this kind is to avoid any linkage with a breach of contract by connecting a repayment obligation to external measures of some kind. These alternative contractual terms are commonly known as “no fault” repayment agreements. These provisions eliminate the risk of being struck down as a penalty clause, and can provide the employer with the ability to require repayment in various different circumstances, including when the bank itself has performed particularly badly in any given year. Whilst it is important that such clauses are drafted to ensure that sufficient clarity exists to allow them to be enforceable, other than this drafting hurdle such a clause can be relatively effective.
Employers generally have not previously used such clauses due to a concern that such a provision in a bank’s standard service agreement may deter strong senior executives from joining. However, depending on the mood of the general public going forward, both in the US and the UK, as well as an increased scarcity of positions at a senior level, banks may well find themselves in much stronger negotiating positions when drafting senior level service agreements.
Some of the suggested models for recovering all or a portion of a bonus already paid without linking this repayment request to contractual breach have been discussed in the context of clawback provisions which are also referred to in the FSA Code. The three common types of clause are as follows:
- Clawbacks due to over-estimated performance - Such a clause can be used when a bonus is linked directly to performance conditions or performance is one of the criteria taken into account when awarding a discretionary payment. The clawback provision will be operative where the performance criteria were initially thought to be satisfied but later turned out to have been overstated. This clause will be effective provided it is exercised objectively and reasonably.
- Clawbacks for negative developments - This provision is triggered by certain specified negative developments occurring within a set period after the bonus is paid. The negative development should be something which is not personally linked to the employee but rather an objective development such as the bank announcing a major loss.
- Clawbacks for unrecognised breach at the time of payments - This form of provision is not as safe legally given its close nexus to the penalty clause principle. However, case law suggests that such a clawback provision which becomes operative when an employer discovers serious breach by the employee (which occurred prior to payment of a bonus) may well be enforceable, and will not be struck down as an unenforceable penalty clause.
The extent to which some or all of these contractual measures will become commonplace will in a large part be shaped by global trends, and in particular the US’s reaction. Now that the world’s key financial centres are so closely aligned, it would be foolhardy to approach these sorts of issues as isolated domestic problems, and any reaction and/or solution will almost inevitably follow the tide of global opinion.
Posted on June 4, 2009 by K&L Gates
By: Anthony R.G. Nolan
The Term Asset-Backed Securities Liquidity Facility (“TALF”) was announced in February 2009 and first implemented in the following month. As an emergency lending facility established by the Federal Reserve Bank of New York (the “New York Fed”) pursuant to Section 13(3) of the Federal Reserve Act, TALF provides non-recourse term financing for the purchase of highly rated asset-backed and mortgage-backed securities at attractive rates. Although it is backed by a $200 billion credit facility from the Treasury, it is not considered a TARP program subject to the Emergency Economic Stimulus Act of 2009 (“EESA”). However, because of the involvement of the New York Fed in the program as well as its close association with TARP, prospective borrowers have had to weigh the political risks of their involvement and the extent to which governmental authorities could access information about their activities and their investors.
In the first three subscriptions that occurred in March, April and May 2009, TALF borrowings financed approximately $16 billion in newly issued asset-backed securities, facilitating over $24 billion in issuance of asset-backed securities. After a slow start, and considerable hesitation by investors over participating in the April subscription owing to political and other risks, the TALF program appears to have come into its own in the May subscription, with approximately $10.5 billion of TALF subscriptions facilitating the issuance of approximately $13.5 billion of TALF eligible securities. Subscriptions for the June funding appear to be on track to increase substantially from the May subscription level.
The acceleration of TALF subscriptions reflects several factors. These include
- expansion of the scope of asset classes eligible for TALF funding;
- clarification by the New York Fed and the Treasury that private TALF participants are not (without more) subject to the executive compensation restrictions of the EESA;
- increased experience with the TALF subscription process and the streamlining of TALF borrowing logistics, which increased the comfort level of investors and others with the program; and
- the sense that TALF was a constructive force in the markets for asset-backed securities and consumer credit.
These considerations acted to counter prospective participants’ concerns about political risk, which appeared to have come to a peak following the disclosure in March 2009 that employees of AIG Financial Products had been paid $165 million in retention bonuses after the company had received TARP funds. However, recent political and legislative developments may make it more likely that Congress will obtain information about TALF investment funds and their investors through audits of the New York Fed or of TALF borrowers by the Government Accountability Office (“GAO”). This concern may dampen the willingness of funds to borrow under TALF to the extent that spreads on TALF-eligible ABS continue to compress to a point where perceived risks outweigh rewards.
The contractual path of transparency is familiar to participants in the TALF borrowing process. Section 11.1 of the TALF Master Loan and Security Agreement (the “MLSA”) authorizes the Federal Reserve Board (the “Board”) to obtain reports or statements that it reasonably requests with respect to the borrowing and the collateral. Section 11.3 of the MLSA also authorizes the New York Fed to obtain “know-your-customer” (“KYC”) information submitted by a borrower to the primary dealer acting as its agent for TALF borrowings.
Primary dealers have recently been expanding the scope of KYC diligence required for TALF investment funds to “look through” the fund to get information about investors who own (directly or indirectly) 10% or more of a class of securities in the fund. The extent of the look-through varies among dealers, with different formulations covering direct, intermediate and/or ultimate owners of the borrower. KYC information is typically given to dealers under confidentiality restrictions, and the MLSA obligates the New York Fed to comply with any confidentiality restrictions. However, the New York Fed is permitted to disclose any information it receives to oversight bodies (including Congress) to the extent required by applicable law or regulations or by subpoena. Once so disclosed, information given in confidence may become publicly available. Therefore, the scope of KYC disclosure that TALF investment funds make to their primary dealers could be a crucial issue for direct and indirect investors in those funds.
The increasing level of KYC diligence has coincided with expressions of concern by the Office of the Special Inspector General for the Troubled Asset Relief Program, in its April report to Congress, that a look-through is appropriate to ensure that TALF not be used to leverage proceeds of crime. Even though TALF is not a TARP program, policymakers and enforcement agencies have been concerned about moral hazard implications of non-recourse TALF borrowings (at a 6-1 leverage ratio) by public-private investment funds established under the Treasury’s Public-Private Investment Program (“PPIP”). This moral hazard arises from the potential of such leverage to dilute the risk of loss of private equity investors in PPIP funds even beyond the dilution implicit in the Treasury’s co-investments in the equity of those vehicles. To the extent that private parties have limited “skin in the game,” they may have disincentives to conduct appropriate due diligence on financed assets or establish a fair price, which could harm a fundamental taxpayer protection in the design of TALF and PPIP by potentially exposing the public purse, as represented by the New York Fed and the Treasury, to a heightened risk of loss.
Recent legislative developments may also be providing a separate avenue to disclosure of information about investors in TALF funds. Section 8.01(d) of the enrolled version of Senate bill S.896 (Helping Families Save Their Homes Act of 2009) permits the GAO to conduct audits, including onsite examinations, of any action taken by the Board under the authorizing legislation for TALF “with respect to a single and specific partnership or corporation.” Section 8.01(c) of that bill provides that it may obtain access to any entity receiving TALF funding in connection with such audits. A separate bill introduced in the House of Representatives, H.R.1207 (Federal Reserve Transparency Act of 2009), provides for a report to Congress with respect to GAO audits of the Board. It appears that sponsors of this legislation conceive of it as a basis for Congress to obtain information with respect to TALF borrowers and their investors.
Posted on June 4, 2009 by K&L Gates
By: Lawrence B. Patent, Charles R. Mills
Recent rule proposals of the Commodity Futures Trading Commission ("CFTC") continue the agency’s interest in securing a stronger regulatory grip on over-the-counter ("OTC") derivatives and protection of customer deposits of futures margin. While it is not surprising that the CFTC would consider such amendments in light of recent economic conditions, the proposals could have the effect of further decreasing the number of future commission merchants ("FCMs"), as well as leading to less-well-capitalized FCMs, and resulting in reduced liquidity in the system just as clearing of OTC derivatives becomes more prevalent.
The proposals would mandate that an FCM’s minimum capital requirements treat cleared OTC transactions in a manner equivalent to exchange-traded transactions. In the same release, the CFTC requested comment on whether to increase the minimum adjusted net capital for firms dually-registered as FCMs and securities broker-dealers ("BDs") to equal the combined (aggregate) net capital requirements of the CFTC and the Securities and Exchange Commission ("SEC"). Currently, these dually-registered firms need only maintain the greater of the amounts required by the CFTC or SEC.
In the October 24, 2008 issue of this Newsletter, we reported on a CFTC interpretation published on October 2, 2008, which states that, in an FCM bankruptcy, claims related to OTC contracts cleared by a derivatives clearing organization ("DCO") will be entitled to the same preferential treatment as claims that are based upon exchange-traded futures contracts. The CFTC’s rule proposals published May 7, 2009 provide that an FCM’s required adjusted net capital include an amount equal to ten percent of the maintenance margin level of customer and non-customer cleared OTC derivative positions. FCMs also would be required to take the same haircuts on proprietary cleared OTC derivative positions that are required for exchange-traded futures and options: 100 percent of maintenance margin if the FCM is a member of the clearing organization, and 150 percent if the FCM is not a member.
Incorporating Cleared OTC Positions Into Minimum Financial Requirements
The proposed amendments would apply to OTC derivatives, including credit default swaps, that are submitted for clearing on any (1) U.S. DCO, (2) non-U.S. clearing organization permitted to clear such transactions under the laws of the relevant jurisdiction, (3) multilateral clearing organization authorized under Section 409 of the Federal Deposit Insurance Corporation Improvement Act, which could also be non-U.S., or (4) securities clearing organization. The CFTC stated that it is proposing these amendments because DCOs have become significant clearers of OTC derivatives and that this development has increased the risk exposure of FCMs in a manner not currently reflected in CFTC regulations. The proposed amendments, however, would extend to OTC derivatives beyond those cleared by DCOs and held in segregated customer accounts, and thereby include OTC derivatives other than those whose holders are to be accorded preferential treatment in the event of the FCM’s bankruptcy.
The idea underlying the CFTC’s proposal – that enhanced capital requirements might be thought to provide greater customer and systemic protections against the risk of defaults by FCMs – must be examined and weighed against the fact that higher financial requirements for FCMs in a poor economy could reduce the number of FCMs participating in clearing OTC transactions, thereby reducing liquidity and concentrating systemic risk among fewer market participants. The CFTC’s proposals might also provide an incentive for FCMs not to submit OTC positions for clearing if the capital impact would be too severe, and may also cause customers to avoid clearing as well if clearing fees would be increased.
Minimum Capital Requirements for FCM/BDs
Although the CFTC did not propose a specific amendment to its regulations concerning the minimum adjusted net capital required for dually-registered FCM/BDs, it solicited comments on whether to change that level from the greater of to the sum of the amounts required by CFTC and SEC. The CFTC explained that it was soliciting comments on this issue because, in the event of liquidation, an FCM/BD’s assets would be available to satisfy any unsecured claims of creditors, including any unsecured claims of futures and securities customers. Requiring that an FCM/BD maintain the sum of the CFTC and SEC minimums would, in the CFTC’s view, reflect more fully the scope of customer business and increase the “equity available to satisfy . . . unsecured claims of customers.”
The CFTC proposal presumes that, if capital requirements are increased, enterprises would continue to organize themselves so that futures and securities business is conducted through a single entity. Currently, a BD may decide that it makes sense to operate its futures business through the same legal entity, because such business is normally smaller than its securities business, and where that is the case, such a structure does not increase its minimum capital requirement (i.e., under the “greater of” formulation, the SEC minimum will exceed the CFTC minimum and the futures business can be done “for free”). However, if that is no longer the case, and a dually-registered firm would experience an increase in its minimum capital requirement, the BD may decide to establish a subsidiary or affiliate that would be registered as an FCM with a relatively modest amount of capital as compared to that maintained by FCM/BDs. If so, and if the separate FCM were forced to liquidate in bankruptcy, there would likely be fewer assets available to satisfy unsecured creditor claims, including unsecured customer claims, than would be the case if the firm were an FCM/BD. A change from the “greater of” standard to a “sum of” requirement could therefore result in fewer assets available to creditors in a bankruptcy.
Comments on the proposal are due by July 6, 2009.
Investment of Customer Funds
The CFTC also recently issued an advance notice of proposed rulemaking concerning the investment of customer funds, which was published in the Federal Register on May 22, 2009. The Commodity Exchange Act ("CEAct") specifies that customer funds related to futures and options traded on a U.S. contract market may be invested by FCMs and DCOs only in U.S. government securities and municipal securities. Nevertheless, beginning in 2000, the CFTC used its general exemptive authority under Section 4(c) of the CEAct to permit the investment of customer funds in other instruments, including government sponsored enterprise securities, bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and interests in money market mutual funds ("MMMFs"). Investment of funds of U.S.-located customers related to futures trading on non-U.S. exchanges is governed by CFTC Regulation 30.7, which does not limit the type of investment of such funds, but requires that an FCM maintain records that include a description of the obligations in which such investments were made.
CFTC Regulation 1.25, which governs the investment of customer funds related to trades made on U.S. contract markets, contains a general prudential standard that all permitted investments be “consistent with the objectives of preserving principal and maintaining liquidity.” The CFTC has been mindful of how important the earnings on investment of customer funds are to the net income of FCMs and thus had been open during the earlier part of this decade to an expansion of permissible investments. The CFTC noted that FCMs have managed the investment of customer funds and Regulation 30.7 funds responsibly during the recent economic downturn. However, the CFTC cited the market events of the past year, notably the failures of certain government sponsored enterprises, difficulties encountered by certain MMMFs in honoring redemption requests, illiquidity of certain adjustable rate securities, and turmoil in the credit ratings industry, as challenges to many of the fundamental assumptions regarding investment of customer funds. Although the CFTC in its advance notice states that it “welcomes comments . . . in support of any new instruments that might qualify as permitted investments,” the general tenor of the notice is directed towards soliciting comments concerning retaining, rescinding, or modifying existing authority. It would appear that the expansion of permissible investments is over.
The CFTC also is soliciting comment about applying the standards of Regulation 1.25 to Regulation 30.7, so that investment of customer funds related to trades on non-U.S. exchanges would be subject to the same limits applicable to funds related to trades on U.S. contract markets.
Any new restrictions on the investment of customer funds are likely to further squeeze the bottom line of FCMs, and contribute to a further contraction in the number of FCMs, which has been cut almost in half over the last 14 years (from 255 in August 1995 to 134 as of the end of 2008).
Comments are due by July 21, 2009.
Conclusion
It is not surprising that the CFTC would consider amendments to its regulations governing minimum capital requirements and the investment of customer funds following recent economic conditions. The proposals and requests for comment referred to above, however, could have the effect of further decreasing the number of FCMs, leading to less-well-capitalized FCMs, and resulting in a diminution of liquidity in the system just as clearing of OTC derivatives becomes more prevalent and desired, and even mandatory.
Posted on June 4, 2009 by K&L Gates
By: Ian Meredith, Sean Kelsey
For investors, advisors, liquidators and institutions contemplating their exposure, or potential exposure, to the European dimensions of Bernard Madoff's Ponzi scheme, there have been notable recent developments in one of the key European centres of the funds industry, where the unwinding of the Madoff scandal has recently intersected with a significant current trend in international commercial dispute resolution.
Many of the Madoff-related claims in Europe are being brought in Luxembourg, estimated to be Europe’s largest funds centre. Prominent among these are suits seeking compensation and access to documents from Luxembourg units of UBS AG (“UBS”), custodian bank for two Madoff feeder funds, Access International Advisors LLC’s LuxAlpha Sicav-American Selection and Luxembourg Investment Fund. More than twenty suits have been dealt with to date, according to reports. Luxembourg’s Treasury and Budget Minister, Luc Frieden, anticipates “dozens” more, and some commentators suggest they could run into the hundreds.
On April 28, Mr. Frieden urged custodian banks, fund liquidators, investors and all other parties to Madoff-related lawsuits in Luxembourg to agree to settle their differences by resort to international arbitration. Mr. Frieden believes that international arbitration - possibly seated in London or Paris - would provide a more appropriate, and a quicker solution than pursuit of such claims through the Luxembourg courts. Mr. Frieden also stated that he believed such an approach would be “in the best interest of the fund industry.”
Any solution along these lines would require the agreement of UBS, and might involve provisions permitting claimants to opt in (rather than requiring them to opt out). In some respects, Mr. Frieden’s proposal chimes with the increasing availability of representative or “class” action as a tool for dispute resolution in a number of jurisdictions around the world, and indeed the uses to which that tool is already being put in connection with Madoff-related claims. In the United States, where class action litigation has been long established, investors are pursuing a variety of such claims against a host of feeder funds and advisors. In the arbitration context, class arbitrations have existed in the United States for over 25 years, and the American Arbitration Association has had rules for their conduct since 2003. At least one New York law firm is reportedly filing a number of Madoff-related group arbitrations. International class arbitration has been gaining in prominence more recently, and several international class arbitrations seated in the United States are currently known to exist. Enforcement, under the New York Convention, of awards resulting from international class arbitrations has, however, the potential to create issues, particularly if parties seek to enforce against assets located in jurisdictions less familiar with the class concept.
In a separate development, on April 24, a Luxembourg court selected a handful of “test cases” from more than fifty Madoff-related lawsuits that have been filed against UBS by individual investors to assess the validity of their claims for compensation. This would appear to hold out at least the possibility that claimants may be willing to pursue class-based lawsuits by way of international class arbitration if they, and UBS, perceive any advantages in doing so.
We will look to provide a more detailed analysis of the disputes landscape flowing from recent upheavals in the capital markets in a future edition of this newsletter.
Posted on June 2, 2009 by K&L Gates
By: Philip J. Morgan, Anna Paglia, Neil Nick Robson, Cary J. Meer, Mark D. Perlow
On 29 April 2009, the European Commission (the "Commission") of the European Union ("EU") published its much-anticipated "Proposal for a Directive of the European Parliament and of the Council on Alternative Investment Fund Managers" (the "Proposal" and the "Directive"). The Commission has indicated its desire to spearhead the world regulatory response to the current financial crisis, with the Proposal forming part of an ambitious Commission programme to extend appropriate regulation and oversight to all activities that the Commission considers present and/or create significant risks.
To view the complete alert online, click here.
Posted on April 15, 2009 by K&L Gates
By: Melanie Hibbs Brody, Stephanie C. Robinson
Advocates for the creation of a new federal financial regulatory body claim that consumer loans and toasters have something in common—both are useful and convenient, but either one could explode in your face. In an effort to protect consumers against the risks associated with risky financial products—particularly the types that contributed to the country’s current foreclosure crisis—Senators Richard Durbin (D-IL), Chuck Schumer (D-NY), and Ted Kennedy (D-MA), and Congressmen Bill Delahunt (D-MA) and Brad Miller (D-NC) recently introduced legislation (S.566 and a companion bill, H.R. 1705) that would create the Financial Products Safety Commission (the “FPSC” or the “Commission”), a federal financial regulatory body designed to protect users of consumer financial products and services from unreasonable risk.
To read the complete alert online, click here.
Posted on March 19, 2009 by K&L Gates
By: Daniel F. C. Crowley, Karishma Shah Page
On February 10, 2009, Treasury Secretary Timothy Geithner outlined the Obama Administration’s plan to address the financial crisis. The Financial Stability Plan (FSP) represents a shift from the previous Administration’s implementation of the Troubled Asset Relief Program (TARP), which focused largely on capital injections into financial institutions under the Capital Purchase Plan (CPP). In addition to continuing capital injections, the FSP expands efforts to increase consumer and small business lending, will create a public-private investment fund to purchase toxic assets from banks, and includes a housing support and foreclosure mitigation component.
Capital Assistance Program
The Treasury Department will continue to make TARP equity investments in certain financial institutions through the Capital Assistance Program (CAP). Under CAP, the 19 largest banking institutions with assets over $100 billion will be required to participate in a coordinated supervisory forward-looking capital assessment (i.e., a “stress test”) to determine whether the firm has the capital necessary to continue lending and to absorb future losses. If Treasury determines that a firm has inadequate capital, it will have six months to raise it privately, and if it does not succeed, it will be compelled to take CAP funds. Banking institutions with consolidated assets of less than $100 billion will also be eligible for CAP funds. Eligibility is consistent with the criteria and process established for CPP.
Capital provided under CAP will be in the form of cumulative mandatorily convertible preferred stock and will carry a nine percent dividend yield. The security will be convertible into common equity, at the issuer’s option, at a ten percent discount to the price prevailing prior to February 9, 2009; however, the security will automatically be converted into common equity if it has not been redeemed or converted after seven years. Treasury will place its capital investments in a newly created entity, the Financial Stability Trust, and will publicly disclose its CAP investments on the Internet. At this time, CAP is only available to publicly traded qualifying financial institutions. The deadline for applying is May 25, 2009.
Consumer and Small Business Lending
The FSP aims to increase consumer and small business lending through a massive expansion of the Term Asset-Backed Securities Loan Facility (TALF) from $200 billion to $1 trillion. The Treasury will provide $100 billion in TARP funds to backstop the Federal Reserve loan facility.
Under TALF, the Federal Reserve Bank of New York (FRBNY) will provide non-recourse funding to eligible borrowers owning eligible collateral. Eligible collateral includes certain asset-backed securities (ABS) that have at least two AAA ratings and that have auto loans, student loans, credit card loans, or small business loans as the underlying credit exposure. The minimum TALF loan amount is $10 million, and the loan will have a three-year term and be subject to either a fixed or a floating interest rate. In addition, the TALF loans will be subject to haircuts ranging from five to 16 percent, depending on the category of the ABS offered as collateral. For additional details on TALF, see K&L Gates Newsstand Alerts The Term Asset-Backed Securities Loan Facility in Sharper Focus and The Term Asset-Backed Securities Loan Facility Takes Form. The initial round of loans will be awarded on March 25, 2009; TALF terms and conditions may be modified for subsequent rounds. The Federal Reserve has indicated that ABS backed by rental, commercial, and government vehicle fleet leases and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment loans and leases might be made eligible for the April funding of the TALF.
In addition, Treasury and the Small Business Administration (SBA) will launch the Small Business and Community Lending Initiative. Although details have not yet been announced, initial plans indicate that the Initiative will finance the purchase of AAA-rated SBA loans in an effort to increase liquidity in secondary markets for small business loans and increase SBA loan guarantees up to 90 percent.
Public-Private Investment Fund
The FSP will also create a much-anticipated new Public-Private Investment Fund (Fund) to purchase toxic assets from banking institutions. The Fund would make these purchases by providing government capital and financing to leverage purchases by private capital. In addition, the Fund would rely on private sector buyers to price the value of the assets. The initial scale of the Fund will be $500 billion, but may be expanded up to $1 trillion. Treasury is expected to release details on the operation of the Fund in the near future.
Homeowner Affordability and Stability Plan
The FSP also includes a housing component, the Homeowner Affordability and Stability Plan (Plan). The first pillar of the Plan will support borrowers who have a solid payment history but are unable to refinance their mortgages because their current loan-to-value ratios are above 80 percent due to a loss in home value. The program would make 4 to 5 million of these homeowners eligible to refinance their existing Fannie Mae or Freddie Mac mortgages at today’s low interest rates.
The second pillar of the Plan, the $75 billion Homeowner Stability Initiative, creates a mortgage modification program for at-risk homeowners that have loans on owner-occupied properties with unpaid balances up to $729,750. Loan servicers must enter into a program agreement with Treasury in order to participate. Participating loan servicers must then apply a net present value (NPV) test on each loan at risk of imminent default or at least 60 days delinquent, unless explicitly prohibited by contract. If the NPV of the expected cash flow is greater under a modification scenario, the servicer must modify the loan such that the monthly payment is no more than 31 percent of the borrower’s gross monthly income. In exchange for the modification, the government will:
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Subsidize the lender or investor for the cost of reducing monthly payments from 38 to 31 percent of gross monthly income;
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Provide servicers with a $1,000 payment for each modification and an additional $1,000 per year for loans that continue to perform; and
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Provide payments of $1,500 to lenders or investors and $500 to servicers for modifications made to borrowers that are current on their payments.
Finally, Treasury will increase funding to Fannie Mae and Freddie Mac through the purchase of preferred stock. In order to fund this commitment, Treasury will use $200 billion made available under the Housing and Economic Recovery Act.
Additional Conditions
Increasingly, government assistance comes with stricter terms and conditions. Firms receiving assistance from the FSP will be subject to the following conditions:
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Recipients will be required to submit lending plans and monthly lending reports. This information will be publicly disclosed on the website financialstability.gov.
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Recipients will be required to commit to participating in mortgage foreclosure mitigation programs consistent with Treasury guidelines.
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Recipients will be restricted from paying quarterly common dividend payments, repurchasing privately-held shares, and pursuing acquisitions until the government’s investment is repaid.
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Recipients are prohibited from certain lobbying activities.
The FSP initiatives will continue to take shape in the coming months as details are released. The K&L Gates public policy group is closely monitoring these developments on behalf of the firm’s policy clients.
Posted on March 19, 2009 by K&L Gates
By: Laurence E. Platt, Kerri M. Smith
Using a trio of tools to triage those whom it realistically can seek to help, the federal government has stepped up its efforts to fight residential mortgage foreclosures. Announcement of the details of the Obama Administration’s Making Home Affordable Program (“the Plan”) on March 4, 2009, makes clear that the federal government will rely on loan modifications, refinancings and cram downs to try to keep borrowers in their homes. In addition, the recent passage of H.R. 1106, Helping Families Save Their Homes Act of 2009 (“H.R. 1106” or “the Bill”), by the House of Representatives, bolsters the Plan’s agenda by allowing bankruptcy judges unilaterally to modify mortgage loans, and providing a safe harbor against investor liability for servicers that make loan modifications subject to the Plan.
While most elements of the Administration’s Plan can proceed without Congressional approval, the House Bill must be passed by the Senate to become law. No one can tell in advance whether these anti-foreclosure lifelines will work in an increasingly deteriorating economy. While the individual consumer who ultimately saves his or her home from foreclosure will appreciate the effort, many investors and unemployed borrowers are less hopeful about these measures.
To view our complete alert online, click here.
Posted on March 19, 2009 by K&L Gates
By: Lawrence B. Patent
Introduction
Gary Gensler, President Obama’s nominee for Chairman of the Commodity Futures Trading Commission (CFTC), testified at his confirmation hearing before the Senate Committee on Agriculture, Nutrition, and Forestry (the “Agriculture Committee”) on February 25, 2009; the Agriculture Committee approved his nomination on March 16. In his opening statement, he mentioned four priorities that he would pursue if confirmed by the full Senate: (1) vigorous enforcement to prevent fraud and manipulation in futures and options markets; (2) position limits across all markets and platforms where there is a finite supply of the underlying commodity; (3) generally requiring the clearing and exchange trading of derivative instruments, and direct regulation of derivatives dealers; and (4) working with regulators around the globe to protect Americans impacted by world financial markets. The first and last of these goals are often cited by nominees to federal regulatory positions, and they are to be expected. The remainder of this article will focus upon his other goals, those concerning position limits and enhanced regulation of derivatives, which represent a departure from the current regulatory framework yet are in keeping with recent legislative initiatives.
Trading and Clearing of Derivatives
Mr. Gensler’s statements at his confirmation hearing are consistent with some of the recent bills before Congress addressing regulation of derivatives and the energy markets. Mr. Gensler did acknowledge that his current views may not be consistent with positions that he took as a senior official in the Treasury Department under President Clinton in the late 1990s, leading up to the passage of the Commodity Futures Modernization Act of 2000 (CFMA). The CFMA provided greater legal certainty for trading in financial and energy swaps by exempting those instruments (and certain related markets) from regulation by the CFTC or the Securities and Exchange Commission (SEC). Mr. Gensler stated that his views have since “evolved” and that there should have been more aggressive regulation of derivatives to protect the American public. Thus, Mr. Gensler’s current views are generally compatible with the regulatory direction of the provisions of H.R. 977, the “Derivatives Markets Transparency and Accountability Act of 2009,” addressing over-the-counter (“OTC”) commodity derivatives. That bill was approved by voice vote of the House Committee on Agriculture on February 12, 2009 (and the subject of a prior K&L Gates Alert). H.R. 977 would generally require the clearing of all swap transactions, but would leave open the possibility of reporting certain swap transactions to the CFTC if a clearing organization did not want to clear them.
S. 272, the “Derivatives Integrity Act of 2009,” which was introduced by Senator Harkin (D-Iowa) on January 15, 2009, goes beyond H.R. 977’s requirement for clearing to require that all swaps be traded exclusively on CFTC-regulated exchanges. That provision would effectively eliminate all OTC transactions in commodity derivatives. Senator Harkin, who is Chairman of the Agriculture Committee, tried to press Mr. Gensler during the confirmation hearing to support the thrust of his bill. Although Mr. Gensler indicated that he generally supported the concept of the greater transparency that would be provided by exchange trading and clearing of swaps, he resisted committing to support exchange trading of all swaps with no exceptions. Mr. Gensler recognized that there could be cases where customized transactions would not fit readily into an exchange-traded, clearinghouse framework, and exceptions might be necessary to accommodate such instruments. Senator Harkin expressed the view that it would be too easy to vary a particular term of a contract so that it could be labeled as “customized” rather than standardized and thereby permit such instruments to evade the exchange-trading requirement.
Regulation of Financial Swap Dealers
Mr. Gensler did express support for another facet of S. 272 -- the regulation of financial swap dealers (H.R. 977 does not provide for such regulation). Mr. Gensler stated that the entities involved in financial swap transactions needed to be subject to minimum financial, business conduct and reporting requirements. He stated that it was not enough for other affiliates of a swap dealer or its corporate parent holding company to be subject to regulation by the CFTC or the SEC; rather, in his view, the entity that is a party to financial swap transactions must itself be subject to minimum financial, business conduct and reporting requirements. Mr. Gensler indicated that the new requirements would apply to the 15 or 20 swap dealers that are involved in the vast majority of such transactions. Such a policy reversal would certainly be a large step away from the exemptive framework for swaps under the CFMA.
Position Limits
Mr. Gensler also indicated his support for H.R. 977’s objective of establishing position limits for physically deliverable commodities that have a finite supply. Part of the original purpose of H.R. 977 when it was introduced last year was to impose speculative limits on energy-related futures and options, because trading in those products has been blamed by many as contributing heavily to the run-up in gasoline prices last summer (although that view is disputed by the CFTC’s Office of Chief Economist and several other studies). In addition, Mr. Gensler expressed support for the regulation of OTC trading of energy and metals in the same manner as agricultural swaps. Agricultural swaps currently trade in accordance with CFTC regulations that date back almost 20 years, rather than pursuant to statutory exemptions, which in the case of energy and metals can fully exclude them from the reach of the CFTC. Accordingly, regulating OTC trading in energy and metals in the same manner as agricultural commodities would confer more power to the CFTC to impose restrictions on such trading. It appears that Mr. Gensler would not slow down efforts to increase the regulatory scrutiny of energy derivatives.
Relief Requests
Legislation regulating derivatives and imposing new speculative limits will likely take several months to finalize. Mr. Gensler also noted during his testimony two areas of CFTC procedures that he would want to review that may not require any additional legislative action (although H.R. 977 would mandate that CFTC conduct such a review). Mr. Gensler indicated that he wants to review any exemptions granted from hedging restrictions and position limits in the past 20 years by the CFTC, and that he also wants to review the “no-action” letter process, which is used, among other purposes, to grant exemptions for foreign energy markets. Mr. Gensler indicated that some decisions on requests for no-action relief could remain at the staff level, but he implied that certain matters previously handled by staff should be considered by the Commissioners. The overall message from Mr. Gensler is clear: his regime as Chairman of the CFTC will tend towards greater regulation and stricter scrutiny of requests for exemption or no-action relief.
Posted on March 19, 2009 by K&L Gates
By: Brian A. Ochs
A little-noticed recent amendment to the Emergency Economic Stabilization Act of 2008, 12 U.S.C. §5221 (“EESA”), may provide the Securities and Exchange Commission (“SEC”) with a prominent role in enforcing the executive compensation and corporate governance requirements under the Treasury Department’s Troubled Asset Relief Program (“TARP”). The amendment, which was signed into law on February 17 as part of the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) (Pub. L. No. 111-5), requires the chief executive officer and chief financial officer (or their equivalents) of any public company that receives TARP funds to certify compliance with EESA’s executive compensation and corporate governance restrictions as part of the company’s annual SEC filing. Much like the required officer certifications regarding internal controls and disclosure controls that have been part of the legal landscape since the enactment of the Sarbanes-Oxley Act of 2002, the effect of the EESA certification requirement is to focus personal responsibility for EESA compliance on CEOs and CFOs, with the potential for securities fraud or other charges to be brought by the SEC in the event of false certifications.
EESA and the Treasury Department’s Interim Rules on Executive Compensation
As originally enacted, section 111(b) of EESA directed that any financial institution that sells troubled assets to the Treasury Department must meet certain standards of executive compensation and corporate governance. These standards included: (1) eliminating incentives for senior executives to take unnecessary and excessive risks that threaten the financial value of the institution; (2) a “clawback” provision for the recovery by the institution of any bonus or incentive compensation paid to a senior executive officer based on financial statements or other criteria that are later proven to be materially inaccurate; and (3) a prohibition on “golden parachute” payments to senior executive officers. (Generally, “senior executives” means the five highest paid officers of the company.)
In October 2008 and January 2009, the Treasury Department announced rules to implement the executive compensation requirements of section 111 for participants in the TARP Capital Purchase Program (“CPP”). (The Treasury Department separately provided guidance for certain other TARP programs.) Among other things, the January rule required the principal executive officer of each participating financial institution to certify to TARP’s Chief Compliance Officer that the institution was in compliance with the executive compensation requirements set forth in EESA. The Treasury Department further noted in the January rule that a false certification could subject the certifier to federal criminal penalties for false statements under 18 U.S.C. §1001. See CPP Executive Compensation Final Rule (Jan. 16, 2009).
The Recovery Act Amendments
The Recovery Act (Section 7001) expanded the significance of these provisions in several important respects. First, it directs the Secretary of the Treasury to impose new and expanded executive compensation and corporate governance standards on all recipients of TARP funds. In addition to the restrictions found in the original section 111, these standards must bar payment of any bonus, retention award, or incentive compensation during the period that a TARP obligation is outstanding (except for payments made in restricted stock comprising no more than one-third of the individual’s total compensation, and not fully vesting during the period that the obligation is outstanding), and must prohibit any compensation plan that would encourage earnings manipulation. The number of employees to which the new compensation limitations apply varies by provision, in many cases going beyond the original five “senior executive officers” to as many as the next 20 most highly compensated officers. In addition, the Recovery Act amendments require SEC registrants that receive TARP funds to establish a board compensation committee, comprised entirely of independent directors, and also require boards of directors to implement company-wide policies regarding excessive or luxury expenditures.
Section 7001 of the Recovery Act also requires the CEO and CFO (or their equivalents) of each recipient of TARP funds that has publicly traded securities to “provide a written certification of compliance by the TARP recipient with the requirements of this section … together with annual filings required under the securities laws….” (Certifications are to be provided to the Secretary of the Treasury if the entity receiving TARP funds is not a publicly traded company.) The SEC has determined that it will not give effect to the certification requirement until the Secretary of the Treasury establishes standards to implement section 7001 of the Recovery Act. This approach follows the views expressed by Senator Christopher Dodd, the author of the executive compensation provisions of the Recovery Act, in a February 20 letter to SEC Chairwoman Mary Schapiro.
Analysis
The requirement that CEO and CFO certifications be filed with a TARP recipient’s annual report to the SEC will unambiguously subject public companies that receive TARP funds and their executives to SEC scrutiny and potential enforcement action for failure to comply with EESA’s executive compensation and corporate governance requirements. This is because any material false statement in an SEC filing may be charged as a securities fraud or other securities violation, depending on the actor’s level of intent. In the current environment, regulators are likely to view a certification that an entity receiving TARP funds is in compliance with requirements concerning executive compensation and corporate governance as being material to investors. In particularly egregious cases, criminal prosecution for securities fraud could also result.
Further, because the CEO and CFO will each be considered the “maker” of statements in the EESA certifications, these executives could be exposed to personal liability under the securities laws for compliance failures that result in false certifications. Since the passage of the Sarbanes-Oxley Act, most companies have instituted formal procedures such as compliance checklists, sub-certifications by managers with line responsibilities, and disclosure committee reviews, to support the CEO and CFO certifications required by that Act. Entities that receive TARP funds will need to consider implementing similar structured processes to support the CEO’s and CFO’s annual certifications under EESA.
Posted on March 19, 2009 by K&L Gates
By: David T. Case, Brendon P. Fowler
With the nearly unparalleled upheaval in world financial markets and the resulting impact on the nation’s financial institutions, many entities have either gone bankrupt or become subject to increasing levels of Government intervention, regulation, and oversight. The Government also continues to consider actions to address “toxic” assets and to stimulate financial activity. While Government action may ultimately lead the way to financial recovery for the broad economy, in some instances the Government may take actions, such as changing federal regulatory schemes and related contracts, that nonetheless inflict harm on individual companies. In those situations, developments in a series of cases relating to an earlier financial crisis may provide guidance in navigating the risks of increased Government regulation and oversight, and the measure of any damages that might be recovered.
During the Great Depression, forty percent of the nation’s home mortgages went into default, and 1,700 of the nation’s approximately 12,000 savings institutions failed. This led to significant Government oversight of the savings and loan, or "thrift" industry, in the form of the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation, as well as the passage of numerous laws such as the Home Owners’ Loan Act of 1933. This regulatory regime remained in place until the financial crisis of the late 1970s and early 1980s, when, in order to retain deposits, thrifts were compelled to offer interest rates to depositors that exceeded the stream of income from the thrifts’ long-term, low-rate mortgages. Over 400 thrift institutions failed by 1983, and by the mid-1980s, it became clear that Government regulatory efforts to resolve the crisis were not succeeding. As a result, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), which resulted in regulations that imposed more stringent capital standards on thrifts. Many thrifts, particularly ones that had acquired failed thrifts under agreements with the Government, were immediately thrown out of compliance with regulatory capital requirements and became subject to seizure by thrift regulators.
A number of thrifts adversely affected by the new regulations sued the Government, alleging that the passage of FIRREA breached the contracts under which the thrifts had previously agreed to acquire other failed institutions. In United States v. Winstar Corporation, 518 U.S. 839, 843 (1996), the Supreme Court held that where the Government entered into contracts with regulated financial institutions, promising to provide particular regulatory treatment in exchange for the assumption of liabilities, the risk of regulatory change fell to the Government, even though Congress subsequently changed the law and barred the Government from honoring its agreements. Following this ruling, the United States Court of Federal Claims and the United States Court of Appeals for the Federal Circuit addressed a series of cases where the allegations were that the Government had indeed breached its contractual obligations to various thrifts through the passage of FIRREA. This group of cases, which is often denoted as the “Winstar-related cases,” may provide significant guidance for any cases that derive from the present crisis.
As a general matter, damages in the Winstar-related cases are based on one of three damages theories: expectancy damages, reliance damages, or restitution damages.
Expectancy, or “lost profit” damages, protect a bank’s expectation interest by seeking to put that institution in as good a position as it would have been had the institution’s contract with the Government been fully performed, without also providing plaintiff with a windfall. If successful, this theory for recovery typically produces the largest quantum of damages for an injured bank, but lost profits have historically been difficult to prove and recover in the Winstar-related context. Nevertheless, a recent Winstar-related decision by the United States Court of Appeals for the Federal Circuit (“Federal Circuit”) upheld the trial court’s acceptance of a lost profits theory that established, by way of expert testimony and models, that the Government’s implementation of FIRREA caused lost profit damages to the affected thrift. See First Federal Sav. and Loan Ass’n of Rochester v. United States, 290 Fed. Appx. 349, 2008 WL 3822567 (Fed. Cir. 2008). The injured thrift established with reasonable certainty its lost profits of $85 million to the satisfaction of the courts, and the Federal Circuit upheld the trial court’s reliance on plaintiff’s damages expert, and the projections of the growth (and profits) the thrift would have experienced absent the Government breach. Id. at 357.
Reliance damages, often sought or pled in the alternative to expectation damages, are intended to address harm resulting from the thrift’s change of position in reliance on its contract with the Government. The underlying principle in reliance damages is that a party who relies on another party’s contractual promise is entitled to damages for any losses actually sustained as a result of the breach of that promise. Glendale Federal Bank v. United States, 239 F.3d 1374, 1382 (Fed. Cir. 2001). In Glendale, the Federal Circuit affirmed the use of a reliance damage calculation because “for purposes of measuring the losses sustained … as a result of the Government’s breach, reliance damages provide a firmer and more rational basis” than the alternative theories argued by the parties in that case. Id. at 1383. Reliance damages can include both pre- and post-breach activities and costs by the thrift, and have been described as the “ideal” theory for “wounded bank” damages. Glendale Federal Bank v. United States, 378 F.3d 1308, 1313 (Fed. Cir. 2004) (upholding trial court’s award of $381 million).
Restitution damages may be sought when proof of lost profits or reliance damages fails. The idea behind restitution is to restore the non-breaching party to the position he would have been in had there never been a contract to breach. Specifically, a restitution theory seeks to recover any benefit that the non-breaching party may have given to the breaching party, but such damages should not be awarded if the award would result in a windfall to the non-breaching party. See Southwest Investment Co., Inv. v. United States, 63 Fed. Cl. 182, 197 (Fed. Cl. 2004). Accordingly, an institution must carefully consider whether benefits conferred on the Government might nonetheless be offset fully by benefits received from the Government, as “the non-breaching party is not entitled, through the award of damages, to achieve a position superior to the one it would reasonably have occupied had the breach not occurred.” Glendale Federal Bank v. United States, 239 F.3d 1374, 1382 (Fed. Cir. 2001). In addition, restitution can be a challenging theory to pursue, for while a party may often be able to show benefits given to the Government, establishing an actual dollar value conferred can be difficult. Id. at 1382 (under theory that thrift assumed risk and relieved Government of liabilities for a period of time in which the Government was able to deal with other failing thrifts, the value of Government’s time was more than zero but there is no proof of what in fact it was worth). Where a specific dollar amount is clearly established, however, restitution may be awarded. See 1st Home Liquidating Trust v. United States, 76 Fed. Cl. 731, 744 (Fed. Cl. 2007).
In sum, the numerous Winstar-related decisions provide a body of law for institutions faced with a rapidly changing bank regulatory environment and possible breaches by the Government with respect to current contracts. Familiarity with the types of damages theories and models employed by past thrift litigants against the Government may help today’s institutions develop a viable remedy if they are harmed by Government action.
Posted on March 19, 2009 by K&L Gates
By: Clare Tanner, Paul F. Donahue
The current turmoil in financial markets has led to an increase in disputes involving financial institutions. Parties may have entered into transactions in better times with little consideration given to the forum in which future disputes would play out. In today’s far more challenging circumstances, the choice of forum may be central to the satisfactory resolution of disputes.
In some areas, it is common for disputes involving financial institutions to be resolved through arbitration. The Financial Industry Regulatory Authority (FINRA) is the largest self-regulatory organization, i.e., non-governmental regulator, for all securities firms doing business in the United States. (FINRA’s rulemaking, however, is subject to approval by the Securities and Exchange Commission (SEC).) Both individual and institutional customers can require a FINRA member to arbitrate disputes. Indeed, most, if not all, securities broker/dealers will refuse to do business with customers who do not agree to arbitrate disputes. Disputes between FINRA members may also be submitted to arbitration.
The financial crisis has resulted in a dramatic increase in the number of cases referred to FINRA arbitration. In 2007, slightly more than 3,000 arbitration cases were filed. In 2008, the number was almost 5,000 and the upward trend has only increased in 2009. The number of cases filed in January 2009 was double that of a year earlier.
An award handed down by a FINRA tribunal last month, arising from transactions in auction rate securities, illustrates the enormous magnitude of disputes arising from the financial crisis and the speed with which they can be resolved through arbitration. The FINRA tribunal ordered Credit Suisse Securities USA LLC, a brokerage unit of the Swiss bank, to pay $400 million to its customer STMicroelectronics NV, a European semiconductor maker. STMicroelectronics claimed it had authorized Credit Suisse to make investments in top-rated securities backed by U.S. Government guaranteed student loans, but instead the funds were invested in collateralized debt obligations some of which were backed by sub-prime mortgages. The entire process including 28 hearing sessions over two months took just under a year. Any court proceeding would undoubtedly have taken far longer. Nonetheless, STMicroelectronics, according to the award, incurred more than $4 million in legal fees during that time.
While FINRA members can be compelled to arbitrate customer disputes and most require their customers to agree to arbitrate disputes, other financial institutions have traditionally been reluctant to commit to arbitration and have preferred to submit disputes to national courts. Some of the risks and benefits associated with arbitration as a means of resolving disputes involving financial institutions can be illustrated by reference to FINRA’s procedures.
Confidentiality
As is common with arbitration, FINRA arbitrations are confidential. The evidence submitted and procedural and substantive hearings are not open to the public. Although FINRA arbitral awards are made public, that is the exception, not the rule for most arbitrations unless the parties agree otherwise. FINRA awards are not necessarily fully reasoned and may simply amount to a requirement that one party pay as was the case in the STMicroelectronics case. Under a recent rule approved by the SEC, however, beginning next month, if both parties request it, FINRA arbitrators will have to give an “explained decision,” i.e., “a fact based award stating the general reasons for the decision” but which need not include legal authorities or damage calculations.
Confidentiality can be a significant attraction of arbitration as it avoids both financial institutions and their institutional clients airing their dirty laundry in public. In current markets, disputes may give rise to a damaging loss of confidence in the financial institution. Equally, even if sophisticated institutional customers feel they have been misled by a financial institution, they may wish to avoid public allegations that they share some responsibility or may not want detailed aspects of their financial dealings laid open to public scrutiny. In disputes between sophisticated commercial enterprises, the risk of adverse publicity is seldom limited to one party.
Arbitration will not be appropriate where a financial institution seeks to establish a legal precedent that will be publicly available. Only a court ruling can provide that and, of course, it can be a double-edged sword.
The Tribunal
FINRA’s arbitration rules for customer disputes generally provide for a three-person tribunal with one “industry member” and two independent members. Under a rule change effective at the end of this month the size of cases to be decided by a single arbitrator will increase to $100,000. Three-arbitrator panels are intended to provide both industry knowledge and experience while also protecting the customer’s interests, but some have criticised such panels as too industry friendly. Under a pilot program now underway for 400 cases, several securities firms have agreed to have panels made up of three independent arbitrators. FINRA’s approach may not be appropriate in all cases and, for example, the arbitration rules of the London-based City Disputes Panel provide that the tribunal will usually consist of a legally qualified chairman and two experienced financial services practitioners.
Given the complex and technical nature of modern financial products, there may be a significant advantage in decisions being reached by tribunals with necessary expert knowledge. Both financial institutions and their institutional customers may prefer such a tribunal to the vagaries of a jury trial in the U.S. The speed at which law and market practice change are such that, even in jurisdictions where disputes may come before an experienced judge, a tribunal made up of industry experts may still be preferable.
Procedure
Recent rule changes have sharply curtailed the ability to obtain a summary determination of a dispute in FINRA arbitrations. The loss of the opportunity of having a frivolous claim dismissed at an early stage may be unattractive for respondents and correspondingly attractive for claimants in those jurisdictions where summary determination is only available to a claimant. However, expedited procedures are available by agreement between the parties in both FINRA arbitrations and in other arbitral rules. Equally, the absence of, or restrictions on, wide-ranging discovery exercises and pre-trial depositions found in FINRA and other arbitral rules may mean that, even without a summary determination, arbitration is still more attractive than litigation through national courts.
Finality
The ability to challenge an arbitration award is usually strictly limited and FINRA arbitration is no exception. The attraction of a final award is that the cost and risk associated with any given dispute can be more easily judged. The prospect of a defaulting party endlessly prolonging the proceedings while attempting to protect assets against enforcement is greatly diminished as is the prospect of a successful party deciding to settle simply to end the bloodletting.
Enforcement
Many financial transactions will have an international element, as illustrated by the STMicroelectronics case. A party may be reluctant to commence proceedings in the home court of the other party fearing “home advantage.” Even if the parties agree to resolve disputes in the courts of a neutral state, many national courts will not permit parties to “manufacture” jurisdiction and simply will not hear such cases. Even when they do, the successful party still faces the cost and difficulty of enforcing that judgment in another country.
Arbitration awards made in a country which is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards can be enforced in any other Convention State, by the local court giving effect to the award as if it were a court judgment. This is subject to limited, mostly due process, exceptions.
Conclusion
Arbitration is not a panacea — as with litigation through the courts, expense and delay can be features of arbitration — but there are advantages for disputes between financial institutions or between financial institutions and their institutional clients, particularly where there is an international element. Even parties who did not commit to arbitration at the outset may still agree, after a dispute has arisen, that arbitration is a more suitable dispute resolution mechanism. A failure to consider arbitration may leave parties at a disadvantage and, of course, it is always best to make the decision at the outset, before disputes arise.
Posted on January 28, 2009 by K&L Gates
By: Claudia Harrison, Katie Hillier
1. Introduction
Since the introduction of the stabilisation measures we reported in the previous edition of this newsletter, the global economic downturn has intensified, prompting the UK government to announce further efforts to combat financial instability and support economic recovery. The new measures both extend and supplement the Special Liquidity Scheme, the Bank Recapitalisation Scheme and the Credit Guarantee Scheme described in the previous edition. They do not have any immediate impact upon the draft legislation we reported previously.
2. Updates on Existing measures
2.1 Special Liquidity Scheme ("SLS") and Discount Window Facility
Upon the closure of the SLS at the end of this month, an alternative source of long-term liquidity will be provided under the discount window facility. This is an existing facility provided by the Bank of England ("BoE") which ordinarily provides liquidity for periods not longer than 30 days and operates on similar principles to the SLS. Under the new proposals, maturity periods of one year will be available with the aim of allowing banks to access longer-term liquidity support on demand. The 30-day facility will continue to be available.
2.2 Credit Guarantee Scheme ("CGS")
The deadline for issuing debt to be guaranteed by this scheme is extended from 9 April 2009 to 31 December 2009. All other aspects of the scheme will remain the same.
2.3 Bank Recapitalisation Scheme
Under this scheme, the UK government invested approximately £20bn in the Royal Bank of Scotland plc ("RBS"). The government is converting the £5bn of this stake that are held in preference shares into ordinary shares, thereby increasing its common holdings from 58% to nearly 70%. This conversion will reduce by approximately £6bn the amount of preference dividends that RBS is required to pay each year to the UK government. In return, RBS has committed to maintaining lending to large corporations, small businesses and homeowners at 2007 levels and to increase its lending activities by £6bn over the next year. These commitments reflect the government's concern to protect the wider economy from the underlying lack of credit in the financial sector.
2.4 Financial Services Authority ("FSA") on Capital Ratios
The FSA has given additional guidance on its expectations regarding capital ratios for banks. No new requirements are currently being proposed, as the FSA considers that the recent recapitalisation exercise undertaken by certain banks has created a sufficient capital buffer to withstand losses and facilitate new lending. The guidance introduces the concept of counter-cyclical measures so that during good years banks build a capital 'buffer' on which they can draw in harder times. The Basel Committee is now working to develop this principle and it is possible that the regulatory framework may be adapted in the longer term.
2.5 Northern Rock
There has been concern that the timetable set by the government for Northern Rock to repay its loans was requiring it to reduce its mortgage lending too quickly. This reduction was working against the government's desire to expand mortgage lending, and so the deadlines for repayment by Northern Rock have been extended.
3. New Measures
3.1 Additional credit guarantee scheme
As well as extending the deadline of the CGS, the government has proposed a new guarantee scheme, commencing in April 2009, for certain triple-A rated asset-backed securities. Eligible securities may be backed by mortgages and corporate/consumer debt and must have transparent structures. Eligibility for institutions will be by the same criteria as the CGS. Further details on this proposal are expected in the next few months.
The rationale for this scheme is, in part, the need to maintain banks' mortgage lending capacity. Typically, mortgage-backed securities have supported a third of mortgage lending in the UK, and the government hopes that a guarantee scheme which supports the market in these securities will help to maintain banks' capacity for such lending activity.
3.2 Asset Purchase Facility
The UK government is allocating a fund of £50bn to be used by the BoE to purchase certain high-quality private sector assets, including corporate bonds, syndicated loans and asset-backed securities. The programme will come into effect from 2 February 2009, and purchases will be funded by the issue of Treasury bills. The BoE will be authorised to use this facility for monetary policy purposes such as meeting the inflation target. Further details of how this facility will operate are expected before the end of January.
3.3 Asset Protection Scheme ("APS")
The UK government, for a fee, will provide banks with insurance against future credit losses on their riskiest assets. The government will assess the likely performance of assets under consideration in order to set the level of probable loss and the fee to be charged. The APS will then cover a substantial part of any loss sustained over and above this probable loss, i.e., the exceptional loss. In addition, in order to incentivise participating institutions to minimise their losses, the institution will also have to bear a proportion (for example, 10%) of the exceptional loss. The scheme is available to UK-incorporated authorised deposit takers with more than £25bn of eligible assets. It intends to target the assets most affected by current economic conditions with a view to reducing uncertainty about the value of such assets. In order to support wider economic recovery, participants will have to provide a commitment to the government to maintain lending to creditworthy borrowers in a commercial manner. Further details of the scheme are expected to be issued by the end of February.
4. Conclusion
The theme running through this latest package of measures is an effort to limit the effect of the financial crisis on the wider economy. In the aftermath of the collapse of a number of high street retailers, and as monthly unemployment increases reach levels last seen in 1991, this objective is understandable. However, it remains to be seen whether on the high street are already beyond the reach of such protection.
Posted on November 17, 2008 by K&L Gates
By: Daniel F.C. Crowley, Karishma Shah Page
The U.S. Department of Treasury (“Treasury”) is conferring with the Obama transition team, led by former Clinton Chief of Staff John Podesta, on policy decisions in order to ensure continuity between administrations. The transition team has also turned its attention to selecting the next Treasury Secretary. The new Secretary is likely to have been involved in the development of programs under the Emergency Economic Stabilization Act of 2008 (EESA, H.R. 1424, P.L. 110-343, click GPO’s PDF Display for EESA text). Possible choices include New York Federal Reserve President Timothy Geithner, Federal Deposit Insurance Commission Chairwoman Sheila Bair, former Federal Reserve Chairman Paul Volcker, and former Treasury Secretaries Larry Summers and Robert Rubin.
President Bush hosted the G-20 summit on November 15 in Washington, D.C. to discuss a globally coordinated response to the financial crisis. European Union leaders have urged the President to join them in devising international regulatory measures to govern the banking industry. In his remarks on November 12, U.S. Treasury Secretary Henry M. Paulson, Jr. underscored the importance of reaching a consensus on a broad-based reform agenda during the meeting. Although President-elect Obama was not expected to formally participate, some delegates were planning to engage with him while in Washington, D.C.
Congress is scheduled to reconvene for one week, beginning November 17. House Speaker Nancy Pelosi (D-CA) and Senate Majority Leader Harry Reid (D-NV) would like to pass a stimulus package, but the Majority Leader has said there may not be enough support. President-elect Obama has stated that if a bill does not pass in the lame-duck session, he will make it his first order of business upon being sworn in. The stimulus bill may be a vehicle for legislative directives relative to the Troubled Asset Relief Program (“TARP”) , especially in the area of preventing mortgage foreclosures. The FDIC has proposed using $50 billion of TARP funds for a loan modification and guarantee program. Senate Banking Committee Chairman Christopher Dodd (D-CT) and House Financial Services Committee Chairman Barney Frank (D-MA) are supportive of the proposal.
As expected, congressional oversight of EESA implementation has continued apace. On October 24, Senators Charles Schumer (D-NY), Jack Reed (D-RI), and Robert Menendez (D-NJ) wrote a letter recommending Treasury adopt guidelines to ensure that institutions use bailout funds to restart lending activities rather than acquisitions or dividends. On October 29, House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid sent a letter urging Treasury to strengthen the interim final rules on executive compensation for CPP institutions. In addition, the following congressional hearings have recently taken place or are planned to take place:
Private Sector Cooperation with Mortgage Modifications
Wed., Nov. 12, 10:00 a.m., 2128 Rayburn Bldg.
House Financial Services Committee
Regulation of Hedge Funds
Thurs., Nov. 13, 10:00 a.m., 2154 Rayburn Bldg.
House Oversight and Government Reform Committee
Oversight of Emergency Economic Stabilization Act
Thurs., Nov. 13, 10:00 a.m., 538 Dirksen Bldg.
Senate Banking Committee
Is Treasury Using Bailout Funds for Foreclosure Prevention, as Congress Intended?
Fri., Nov. 14, 10:00 a.m., 2154 Rayburn Bldg.
House Oversight and Government Reform Committee’s Subcommittee on Domestic Policy
Troubled Asset Purchase Program Oversight
Tues., Nov. 18, 10:00 a.m., 2128 Rayburn Bldg.
House Financial Services Committee
Collapse of Fannie Mae and Freddie Mac
Tues, Dec. 9, 10:00 a.m., 2154 Rayburn Bldg.
House Oversight and Government Reform Committee
Congress is preparing to consider comprehensive financial services reform legislation early next year. Senator Schumer, a member of both the Senate Finance and Banking Committees, has outlined six principles that he believes should guide the deliberations:
- A key focus should be on controlling systemic risk and ensuring stability.
- The regulatory structure should be unified under a single regulatory authority, or at a minimum, simplified.
- Complex financial instruments should be subject to regulation under clear regulatory authority.
- Global financial markets require globally coordinated solutions.
- Increased transparency should be a central goal.
- The laissez-faire view of regulation must come to an end.
For more details on the impact of the recent election on current and future policy initiatives relating to the financial services industry, please see the recent K&L Gates Public Policy and Law Alert, “Financial Services Reform: What Comes Next?”
The K&L Gates Public Policy & Law group consists of senior, bipartisan policy professionals who are closely monitoring these developments in order to provide insights to and effective advocacy on behalf of firm clients.
Posted on November 17, 2008 by K&L Gates
By: Richard S. Miller, Robert T. Honeywell, Jeffrey N. Rich
The Lehman Brothers bankruptcy sometimes seems to have exhausted the list of “biggest ever” superlatives: Biggest ever bankruptcy filing in the United States ($639 billion in assets). “By far the largest securities broker-dealer liquidation ever attempted,” according to the trustee overseeing the liquidation of Lehman’s U.S. broker-dealer. His British counterpart, overseeing the insolvency of Lehman’s London operations, told the press, “Enron and BCCI were large and complex but not on this scale.” The Lehman collapse has been tied to the fall of the investment banking model, to continuing uncertainty in financial markets, and to the current turmoil in the global economy itself.
A less-discussed theme of the Lehman bankruptcy is the strain it is revealing between the efficiencies of global corporate cash management and the legal regimes governing creditor claims. When the cash literally stops flowing, creditors and investors naturally ask, “Where’s my money?” The Lehman insolvency has revealed, like many of the largest corporate bankruptcies in recent years, that this can be an extremely difficult question to answer.
Part of the problem is that most corporate cash management systems involve one corporate entity moving cash on behalf of its affiliates, but reflecting their interests primarily through intercompany claims. This has obvious operational efficiencies, but when “the music stops” upon a bankruptcy filing, the cash is held by the entity with legal title to it (i.e., in its accounts). Creditors of the entity holding the cash have an immediate enforcement advantage – the money is there – while creditors of its affiliates have to chase it down, possibly across jurisdictional boundaries. The Lehman bankruptcy is the latest example.
Like most large companies, Lehman operated a centralized cash management system that had one entity – in this case the holding company – operate as the “central banker” for the numerous Lehman entities. According to court filings, the holding company generally swept excess cash into its own U.S. and foreign operating accounts and used it to fund expenses of subsidiaries. The degree to which subsidiaries were integrated into the system varied. For example, unregulated subsidiaries had their excess cash swept on a daily basis to the holding company’s operating accounts, while regulated subsidiaries (generally broker-dealers) transferred cash to the holding company less frequently, to pay down intercompany loans for prior advances. Some subsidiaries managed their own cash and disbursements independently (e.g., Lehman Brothers Commercial Bank). Others had some of their collections deposited into the accounts of other subsidiaries. For example, the regulated U.S. broker-dealer (Lehman Brothers Inc. (“LBI”)) received collections from some derivatives, futures and foreign exchange transactions of Lehman Brothers Commercial Corporation, Lehman Brothers Special Financing Inc., and Lehman Brothers International (Europe) (“LBIE”). As to disbursements for expenses, the holding company acted as “paymaster” for most of Lehman’s European operations, while the regulated U.S. broker-dealer (LBI) acted as “paymaster” for most U.S. operations.
A centralized cash management system such as Lehman’s may make utter sense pre-bankruptcy, but can produce legal nightmares afterward. For one, the sheer number of transactions can make untangling intercompany claims based on those transactions a herculean task. Lehman reported that the portion of its business related to the sale of derivatives alone involved approximately 1,500,000 transactions with approximately 8,000 counterparties. It is now faced, in the post-bankruptcy setting, with sorting these out with a radically reduced staff, going from more than 13,000 employees to about 140. Lehman’s London office recently lost over half of its legal staff. Its current U.S. management, led by an outside restructuring firm, is reportedly focused on preserving its information systems and retaining employees, and estimates being able to respond to creditor inquiries in 45-60 days. Impatient creditors in the U.S. case have filed motions for their own investigations and for the appointment of an examiner and for an independent trustee to replace Lehman’s remaining officers and directors. Its UK insolvency administrators reported difficulty determining the UK companies’ assets, partly due to difficulties getting information from other asset custodians around the world, and that “it will take many years to finally resolve the inter-company and third-party claims.”
A review of Lehman’s cash management system also shows that numerous legal and regulatory regimes are now at play that may affect intercompany claims and, as a result, creditors’ ultimate recoveries. The holding company that acted as the “central bank” is now subject to the U.S. Chapter 11 case, along with 16 subsidiaries; LBI is subject to a separate liquidation proceeding supervised by the Securities Investor Protection Corporation; LBIE and three other British entities are in a UK administration proceeding; other foreign subsidiaries are subject to insolvency proceedings in their own jurisdictions (for example, in Hong Kong, Australia, Singapore, Japan, The Netherlands, France and Germany); and various Lehman entities and funds are still “non-debtors,” not having yet filed a formal insolvency proceeding and thus continuing to be subject to whatever laws govern the entities and their various contracts.
From an insolvency perspective, this means that a creditor or investor evaluating its recovery prospects must:
- first determine which entity or entities it did business with, both directly and through guaranties, cross-collateralization, setoff and netting rights; then
- determine which assets (including collateral) are available for recovery and which courts and regulators may have jurisdiction over those assets (including a possible stay or injunction prohibiting enforcement or foreclosure); then
- file claims in the relevant insolvency proceedings prior to the applicable deadlines (subject to considering the risks of submitting to jurisdiction), exercise any voting and participation rights available to creditors (for example, attending creditors’ meetings and voting on a plan of reorganization), and possibly take other enforcement action (for example, a motion to modify any stay against foreclosure or other litigation); then
- monitor the relevant insolvency proceedings, to determine the timing and amount of creditor recoveries.
The multiplicity of bankruptcy regimes now governing Lehman means that each Lehman entity is now considered a separate “bankruptcy estate” – i.e., a separate group of assets and creditors – and each is now vying with the other bankruptcy estates for a piece of the Lehman group’s remaining assets. Intercompany claims are often the main vehicle through which these separate bankruptcy estates try to recover assets for themselves. Anyone who has lived through other large corporate bankruptcies (e.g., Adelphia, Global Crossing, Refco) knows that intercompany litigation can be the most complex, intractable and even unresolvable feature of the insolvency proceeding. Some cases feature creditors attempting to “substantively consolidate” all of the companies by collapsing all of the different bankruptcy estates into one, eliminating intercompany claims in the process, but other creditors naturally, and fiercely, resist. Some creditors will of course benefit from corporate separateness by preserving their respective debtor-companies’ assets for themselves.
Creditors and investors of the “asset-weak” companies try to reach through corporate boundaries by any and all means. If they are unsuccessful, their recoveries can be much lower than their counterpart creditors at other entities in the corporate tree, in what is ostensibly the “same company.” A typical pattern is that lenders and investors at one level (for example, stockholders and bondholders of the holding company) assert that they financed the operations of the subsidiaries and should recover accordingly; conversely, creditors of the subsidiaries assert that holding company creditors were aware of their “structural subordination” and have to live with the consequences.
Hence, the (often furious) litigation that attends many complex corporate bankruptcies and is now gathering steam in the Lehman cases. In addition to the multiple insolvency proceedings around the world, there are now securities class actions and criminal investigations, all of which will presumably take years to resolve. One of the well-publicized complaints is from creditors of Lehman’s UK entities, who claim that several billion dollars was swept into Lehman’s U.S. accounts on the eve of its Chapter 11 filing. These creditors are now faced with trying to claw back cash that once flowed easily within “Lehman Brothers” and is suddenly beyond their reach due to legal boundaries that became very real, and difficult to pierce, upon Lehman’s bankruptcy filing.
This is one of the difficult lessons that is learned repeatedly in corporate bankruptcies but is especially potent for companies with global operations. At a court hearing, one of Lehman’s lawyers explained its cash management system as “cash moves around with great velocity.” This can be profitable for creditors in good times yet very dangerous in others. Creditors should be aware of the benefits and risks of centralized cash management – specifically, of exactly which entities they have claims against, and where those entities’ cash and other assets are – so that they can understand and be prepared for the consequences in the event, “the music stops.”
Posted on November 17, 2008 by K&L Gates
By: Stanley V. Ragalevsky, Sean P. Mahoney
Federal Deposit Insurance Corporation (“FDIC”)-insured depository institutions, bank holding companies, financial holding companies and certain thrift holding companies have until December 5, 2008 to decide whether to participate in the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”). FDIC established the TLGP as of October 14, 2008 after determining that rapid and substantial outflows of uninsured deposits from banks threatened the stability of our financial system. The purpose of the TLGP is to preserve public confidence and encourage liquidity in the banking system. Participation by FDIC-insured institutions is voluntary.
The TLGP has two components: an FDIC guaranty of certain senior unsecured debt ("Debt Guarantee Program") and unlimited FDIC deposit insurance coverage for non-interest bearing transaction accounts through 2009 ("Transaction Account Guarantee Program"). Under the Debt Guarantee Program, covered debt in an amount up to 125 percent of the senior unsecured debt of a participating institution outstanding on September 30, 2008 that matures no later than June 30, 2009 will be guaranteed by FDIC, for an annual fee of seventy-five basis points of the covered amount. Covered senior unsecured debt includes commercial paper and unsecured borrowings from Federal Reserve Banks but excludes derivatives, deposits in foreign currency, and convertible debt. If investors in an institution's unsecured debt do not insist upon the FDIC guaranty, the cost of the Debt Guarantee Program may not be a worthwhile expense.
The Transaction Account Guarantee Program supplements existing FDIC insurance with temporary, unlimited deposit insurance coverage on non-interest bearing transaction accounts such as demand deposit accounts, payroll and other processing accounts, certain custodial accounts for loan servicing or similar activities and non-interest bearing savings accounts into which funds from transaction accounts are swept. Institutions that participate in the Transaction Account Guarantee Program will be assessed an annual premium in an amount equal to 0.10 percent of covered transaction account balances in excess of standard FDIC coverages.
Although it is theoretically voluntary, participation in the Transaction Account Guarantee Program may effectively be mandatory for most banks that depend upon commercial demand deposit accounts for funding. The market may simply demand this coverage. This may not be the case for institutions with specialized balance sheets or business models.
Institutions have until 11:59 p.m. (EST) on December 5, 2008 to opt out of participation in the Debt Guarantee Program or Transaction Account Guarantee Program. For institutions that do not opt out, the TLGP is scheduled to expire on December 31, 2009, although senior unsecured debt guaranteed under the TLGP will remain guaranteed until the later of maturity or June 30, 2012. Each institution will be required to disclose whether or not it is participating in the Transaction Account Guarantee Program. If an institution participates in the Debt Guarantee Program, it will have to disclose to investors in a commercially reasonable manner whether or not the debt instrument being offered is guaranteed under the TLGP.
Posted on November 17, 2008 by K&L Gates
By: Rebecca H. Laird, Edward G. Eisert
On September 22, 2008, in simultaneous actions, the Federal Reserve Board (“FRB”) announced that it had approved the joint application of The Goldman Sachs Group, Inc. and Goldman Sachs Bank USA Holdings LLC (collectively, “Goldman Sachs”), and the joint application of Morgan Stanley, Morgan Stanley Capital Management LLC and Morgan Stanley Domestic Holdings, Inc. (collectively, “Morgan Stanley”), to become bank holding companies. Each company already owned an institution insured by the Federal Deposit Insurance Corporation (“FDIC”) (a Utah industrial loan company), which was converted into a commercial bank with full deposit taking and lending powers. Though initially bank holding companies, Goldman Sachs and Morgan Stanley have each stated their intention to become a “financial holding company,” i.e., a company that is permitted under the Bank Holding Company Act of 1956 to engage in activities that are “financial in nature,” including securities underwriting, merchant banking, and insurance underwriting and sales (“FHC”).
Set forth below are answers to a number of frequently asked questions about the regulatory implications of an investment banking firm, such as Goldman Sachs or Morgan Stanley, becoming an FHC:
- What are the minimum capital and liquidity requirements for a company to become an FHC? The FHC’s bank must be “well-capitalized” on a consolidated basis, which means that the bank must maintain a “total risk-based capital ratio” of 10.0 percent or greater and the bank must maintain a “Tier 1 risk-based capital ratio” of 6.0 percent or greater. The “total risk-based capital ratio” is the ratio of total capital to assets, which are calculated on a risk-weighted basis. The “Tier 1 risk-based capital ratio” is the ratio of Tier 1 capital – basically common and perpetual preferred stock and surplus minus goodwill and intangibles – to total assets, which are calculated on a risk-weighted basis. In addition, the bank’s leverage ratio, which is the ratio of capital to total assets (which are not calculated on a risk-weighted basis), cannot be less than 3.0 percent. The FRB has stated that at least 100 to 200 basis points above the 3.0 percent leverage ratio is required of all but the very strongest banking organizations. There are no express liquidity requirements in the regulations.
- How would an investment banking firm have to restructure its business if it were to become an FHC? An FHC is permitted to engage in activities that are “financial in nature,” including securities activities, insurance activities, and other financial services activities, such as merchant banking and private equity investing, and may do so in addition to owning banks under a single corporate umbrella. To the extent an activity of an investment banking firm is not “financial in nature” and is not in compliance with applicable regulations, the firm would have two years in which to divest the activity, which the FRB may extend for three one-year periods.
- What discretionary powers does the FRB have over an FHC? The FRB is vested with broad supervisory powers and enforcement tools with which to oversee FHCs. The FRB has the power to conduct examinations, not just at the bank level, but at the holding company and affiliate level. The FRB conducts examinations on a regular basis at each supervised institution and maintains offices at, and continuously monitors the activities of, the largest holding companies. In addition to its general rulemaking authority, the FRB also imposes reporting requirements, restricts activities, imposes operational and managerial standards, and may bring enforcement actions to maintain the “safety and soundness” of the companies it regulates. The FRB also has the authority to require undercapitalized FHCs to take “prompt corrective action” to raise additional capital or find a merger partner.
The jurisdiction of the FRB does not supplant the jurisdiction of other federal banking regulators (such as the FDIC) over the banks owned by the FHC, or state banking regulators over such banks organized under state law. Perhaps most importantly from the investment banking perspective, the SEC remains the primary federal regulator of any registered broker-dealer and investment adviser controlled by the FHC, and the Commodity Futures Trading Commission remains the primary federal regulator of any registered commodity trading advisor, commodity pool operator and futures commission merchant controlled by the FHC. However, the FRB retains ultimate supervisory authority.
This multifaceted regulatory regime has far-reaching and significant consequences for new FHCs, including the regulatory compliance programs that are required and the manner in which regulatory examinations and deficiencies are addressed. For example, historically, the FRB and other bank regulators have been viewed as “prudential” regulators that apply a more “principles based,” collaborative approach to supervision, which is often handled behind closed doors on a confidential basis, as opposed to federal and state securities regulators that are generally viewed as more public-action, enforcement-based regulators.
- What are the rules on capital for separate subsidiaries of FHCs and how does the FRB regulate transfers of funds from subsidiaries? In general, the FRB wants the FHC to be a source of strength to the bank; it does not want the bank to be used to support the FHC. Consequently, the FRB will generally not allow funds to flow from the bank to the FHC to support its debt, pay dividends or fund general operations, unless there is clearly no detriment to the bank in doing so.
Posted on November 17, 2008 by K&L Gates
By: Gordon F. Peery
Prior to September 15, 2008, portfolio managers placed thousands of trades with brokers at Lehman Brothers Inc. (“LBI”) in New York City. These trades, many of which were subsequently transferred for settlement to LBI affiliates throughout the world, eventually failed to settle last month (and are referenced in settlement parlance as “trade fails”) as a result of the worldwide collapse of Lehman Brothers and the landmark civil proceedings that followed on at least three continents. The circuitous routes taken by these trades prior to settlement failure and the legal and business implications along the way demonstrate the complexity of the global system of modern finance and the need for qualified legal counsel.
As of this time, two sets of authoritative statements have been issued with regard to certain trade fails involving LBI.
SIPC Protocol and LBI Trustee Statement. The Securities Investor Protection Corporation (“SIPC”), on September 26, 2008, published a protocol for closing certain open trades (“SIPC Protocol”). The LBI bankruptcy trustee (the “LBI Trustee”) issued a related clarifying statement (“LBI Trustee Statement”).
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SIFMA RMBS Protocol. The Securities Industry and Financial Markets Association (“SIFMA”), on October 9, 2008, published Protocol 08-02 for resolving certain outstanding agency mortgage-backed security trades with LBI (the “SIFMA RMBS Protocol”).
In light of the foregoing developments, the short and long term tasks for handling related Lehman trade fails are as follows:
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Understand the relevant players, law and timing. With the assistance of qualified legal counsel in the appropriate jurisdiction, the first step is to identify
- the relevant trades and the Lehman entity that is properly deemed to be the counterparty,
- the particular court/trustee/administrator that will have authority to resolve issues relating to the trades, and
- the time periods under the relevant protocols for securing rights and performing obligations.
Missing deadlines for filing claims in proceedings may result in the loss of important rights, including the right to recover losses.
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Determine whether any contractual obligations are subject to a stay. Counsel’s early efforts should focus on establishing a legal, contractual obligation that is enforceable in light of applicable insolvency proceedings. Prime brokerage agreements often set forth remedies for trade fails and, so long as the transactions are not stayed by a Chapter 11 proceeding, stayed in a SIPC proceeding, or UK or other administration, contractual rights may be pursued with the advice of counsel and in accordance with applicable settlement protocols.
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Interface with the relevant trustee or administrator. Perhaps the most important step throughout the process is properly interfacing with the appropriate trustee or administrator in a timely manner. In many cases the trustee, legal counsel representing the trustee—or both—will communicate important milestones, deadlines and, in some cases, settlement protocols.
More generally, with respect to trades involving non-LBI counterparties, affected parties would be well advised to reexamine their current forms of trade documentation. Agreements should include terms that are consistent with current market practice, the law and the global arrangements relating to trade execution and settlement. While the extraordinary efforts to resolve LBI trade fails seem likely to yield favorable solutions, many of these issues may arise in other situations today and in the future.
Posted on November 17, 2008 by K&L Gates
By: Stephen C. Glazier
On October 30, 2008, in an en banc decision, the U.S. Court of Appeals for the Federal Circuit handed down the In re Bilski decision. This was a much-awaited decision that addressed the question of what subject matter may be considered for patentability in software, financial services, business methods and telecom services. After citing the Supreme Court precedent in Gottschalk v. Benson, 409 U.S. 63 (1972), Parker v. Flook, 437 U.S. 584 (1978), and Diamond v. Diehr, 450 U.S. 175 (1981), the Federal Circuit, in stating the “definitive test” provided by the Supreme Court for determining whether a “process” may be considered for patentability under Section 101 of the Patent Statute, said that process is “surely patent-eligible if: 1) it is tied to a particular machine or apparatus, or 2) it transforms a particular article into a different state or thing.” This test is referred to as the “machine or transformation” test. (Patent eligibility under Section 101 is only the first hurdle to issuing a valid and enforceable patent. If a patent application claims patent eligible subject matter under Section 101, then the patent must still be novel under Section 102, and non-obvious under Section 103.)
The Bilski decision rejects other tests previously adopted by the Federal Circuit for potentially patentable subject matter under Section 101, specifically rejecting the test in State Street Bank & Trust Company v. Signature Financial Group, 149 F.3d 1368 (Fed. Cir. 1998), and AT&T Corp. v. Excel Communications, Inc., 172 F.3d 1352 (Fed. Cir. 1998), which states that the potentially patentable methods of software or business methods must “produce a useful concrete and tangible result.”
After stating the machine or transformation test, the court goes on to state that “certain considerations are applicable to analysis under either branch [of this test]. First, as illustrated in Benson, the use of a specific machine or transformation of an article must impose meaningful limits on the claim scope to impart patent-eligibility. Second, the involvement of the machine or transformation in the claim process must not merely be insignificant extra-solution activity.”
The court goes on to say that it may in the future further refine the machine or transformation test. In particular, it may further carve out special rules for patent eligibility where the machine in question is a “computer”; however, the court specifically leaves this further development of case law for possible future action. Specifically, the court says “issues specific to the machine implementation part of the test are not to be decided today. We leave to future cases the elaboration of the precise contours of machine implementation as well as the answers to particular questions such as whether and when recitation of a computer suffices to tie a process claim to a particular machine.” Further, the court says “we agree that future developments in the technology and the sciences may present difficult challenges to the machine or transformation test, such as the widespread use of computers and the advent of the Internet has become the challenge in the past decade.” The court further states “and we certainly do not rule out the possibility that this court may in the future refine or augment the test or how it is applied. At present, however, and certainly for the present case, we see no need for such a departure and reaffirm that the machine or the transformation test is properly applied as the governing test for determining patent eligibility of a process under Section 101.” The term “machine” is commonly used in the practice and includes computers and programmed apparatus.
The new Bilski test will be a problem for that small percentage of business method patents and patent applications that cannot be drafted to include any machine or physical transformation of matters; however, the no-technology, purely “mental step only” invention has never been a large percentage of the U.S. patent portfolio. And, apparently, all software embodied inventions may be drafted to be tied to a machine.
For existing patents and patent applications, Bilski might suggest an opportunity to audit current portfolios of interest for possible modification of pending claims in patent applications, and to audit issued patents to modify issued claims in issued patents, where reissues are possible to more precisely comply with the Bilski test.
Further, case law should be monitored for possible further refinements in the application of the Bilski test. Specific issues, such as possible modification of the machine requirement where the machine is a computer, should be watched for.
As for planning business patent strategies, we can expect, until any further case law development in this area, continued growth in the population of software and computerized business method patent applications and issued patents, and in related enforcement and transactions. However, as is always the case in the development of case law, we must keep alert for the next shoe to drop.
Posted on October 24, 2008 by K&L Gates
By Edward G. Eisert and Mark D. Perlow
On September 30, the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”) and the Staff of the Financial Accounting Standards Board (“FASB Staff”) issued guidance on the determination of “fair value” under FAS 157 (the “FAS 157 Guidance”), addressing the use of internal assumptions, the use of broker quotes, and transactions in disorderly or inactive markets to measure fair value. On October 10 , the FASB published a FASB Staff Position (“FSP”) intended to clarify the application of the FAS 157 Guidance. FAS 157, which became effective in November 2007, defines “fair value” as the price that would be obtained in an orderly transaction between market participants in the principal or most advantageous market.
The FSP provides an illustrative example to demonstrate how the fair value of a financial asset might be determined when there is a “disorderly” or “inactive” market and the basis on which a determination could be made that a market is, in fact, "inactive." Although the FSP provides helpful commentary on the FAS 157 Guidance, it does not eliminate the need for investors and auditors to make difficult judgment calls.
The FAS 157 Guidance and the FSP were issued in response to a campaign by the banking industry, based on the argument that the emphasis under FAS 157 on “fair market” valuations for financial assets was forcing banks to write down performing assets to “fire sale” or distressed prices, compelling them to sell more assets to raise capital, and thereby depressing prices further in a downward spiral. Conversely, many supporters of FAS 157, including investors’ groups, have expressed the view that current market values provide a more accurate picture of the health of financial institutions than values based on cost or cash flow models. The SEC rarely involves itself in FASB policy-making, and the SEC’s action is clearly an attempt to reach a compromise between the two positions: it relaxed the interpretation of some of FAS 157’s market valuation provisions, but did not suspend market valuation, as some have requested.
The compromise has not appeased either side in the debate. Some in the industry continue to believe that the FAS 157 Guidance and the FSP do not go far enough. On October 13, in a letter to Chairman Cox of the SEC (the “October 13 Letter”), the American Bankers Association (“ABA”) commented that FASB’s fair value standard “needs serious work,” that it “is always going to create a downward bias on values” and requested the SEC “to use its statutory authority to step in and override the guidance issued by FASB.” http://www.aba.com/aba/documents/press/ChrmnCoxLtr.101308.pdf. Two specific issues highlighted by the October 13 Letter are the requirement in the FSP that “liquidity risk from the buyer’s perspective” be included in cash flow calculations that can be used to determine fair value and that the FSP did not address “other than temporary impairment” in an illiquid market. In addition, a number of members of Congress have been making public statements calling upon the SEC to suspend mark-to-market accounting, thereby politicizing the issue.
Apparently in response to the October 13 Letter and Congressional pressure, on October 15, in a joint letter to Chairman Cox, the Center for Audit Quality, the Consumer Federation of America, the CFA Institute and the Council of Institutional Investors “expressed grave concern regarding recent calls for the SEC to override [the FAS 157 Guidance] that would effectively suspend fair value or mark-to-market accounting.” http://www.thecaq.org/newsroom/pdfs/SECJointLetter2008-10-15.pdf. The joint letter did not specifically mention the October 13 Letter or address the specific issues it raised.
Underlying these positions is a basic disagreement as to the role that the adoption of FAS 157 has played in the liquidity and credit crisis. The ABA believes that FAS 157 has had a significant detrimental impact on the crisis, while auditor and investor groups believe that the crisis was not caused by fair value accounting and that, in fact, FAS 157 has been helpful in exposing problems.
In time-honored Washington fashion, this controversy is now being simultaneously addressed and avoided through a study group. The Emergency Economic Stabilization Act mandates that the SEC “in consultation with the [Federal Reserve Board and the Secretary of the Treasury] shall conduct a study on mark-to-market accounting standards as provided in [FAS 157], as such standards are applicable to financial institutions, including depository institutions.” The SEC is required to submit a report of such study (the “SEC Study”) no later than January 2, 2009 (that is, after the election, but before the new Congress takes office), including “such administrative and legislative recommendations as the [SEC] determines appropriate.”
Work on the SEC Study has commenced and the SEC has announced that it is scheduling public roundtables to obtain input from “investors, accountants, standard setters, business leaders, and other interested parties.”
With the preparation of third quarter financial statements now in process, presumably in reliance on the FAS 157 Guidance and the FSP, and the SEC Study underway, with further public input to be provided, it appears likely that any further regulatory action on these issues will be deferred until 2009, when it will unquestionably be a subject for further debate during the upcoming effort by Congress to reform financial regulation.
We will continue to provide updates on these important issues as events unfold.
Posted on October 24, 2008 by K&L Gates
By Robert V. Hadley and Philip J. Morgan
Last week, two leading UK newspapers reported interviews with the new Chairman of the FSA, Lord Adair Turner, in which he is said to have warned that the days of “soft-touch regulation” are over. He also spoke of the FSA’s plans to pump more resources, and to recruit high quality people from the private sector at considerable expense, into the regulation of systemically important institutions.
Earlier last week FSA Chief Executive Hector Sants struck a slightly different tone when he noted that the concept of “heightened supervision” - jargon for an FSA enhanced regulatory regime for banks where failure appears possible - was a last resort. He also said that the term “heightened supervision” was a colloquialism that reflects the fact that the FSA adopts a risk-based approach. Certain risks now being clear it is appropriate, and consistent with the FSA’s stated and historic approach, and nothing new, for supervision in relation to such risks to be “heightened.”
The new Chairman is plainly looking to stamp his authority in a very public way. Interviews with national newspapers are not a common occurrence for leaders at the FSA. And “light-touch regulation” has long been a mantra of FSA leaders, Mr Sants included. But does Lord Turner's intervention last week signal a real change of direction for the FSA?
Risk-based regulation, which continues to be at the heart of the FSA’s approach, and light-touch regulation run hand in hand - a business that presents a limited risk to the FSA’s statutory objectives can be regulated in a less hands-on fashion than higher risk businesses the failure of which may have systemic consequences. We suspect therefore that many people regulated by the FSA will notice little difference with the tougher stance signalled by Lord Turner.
On the other hand, it is clear that the FSA is currently far more focused, as a matter of necessity, on issues that can have consequences for the stability of the financial system as a whole. Lord Turner mentioned in particular FSA work in three areas:
(i) the capital adequacy regime for banks - in relation to which he noted that the current regime seems to encourage the banks to lend too much in the boom times and too little when times get tough;
(ii) liquidity - where the focus would be on whether the business model of financial institutions was solid enough in bad times as well as good; and
(iii) pay - although Lord Turner was clear that this area plays second fiddle to capital adequacy and liquidity
Also, it would appear that under Lord Turner's watch the FSA will be taking a renewed close look at the risks posed by hedge funds. For example, it was reported that he thinks that hedge funds, up to now beneficiaries of “light-touch regulation” in the UK, could evolve to pose a systemic risk, much as the Wall Street banks did during the past few decades.
The truth, it seems to us, is that whilst the FSA is set to get tougher with high-impact, systemically important firms, notably significant banks and insurance companies, much of the rest of the FSA’s work will probably carry on as before, at least for a while. Lord Turner himself summed up the balancing act as follows:
“There is no doubt the touch will be heavier… We have to make sure that it is intelligent and focussed on where the risks really are.”
It does remain interesting, though, that the new Chairman, unlike the last, does not seem minded to defend the concept of “light-touch regulation,” even choosing to refer to it by the more pejorative “soft-touch regulation.” It remains to be seen whether Mr. Sants will adjust his tone to be more in keeping with his new boss’s tough talking.
Posted on October 24, 2008 by K&L Gates
By Marcus M. Birch and Ian Meredith
Over recent weeks, governments on both sides of the Atlantic have intervened in the affairs of banks and other financial institutions in a quite unprecedented manner.
The government-initiated rescues have had an undoubted impact on private investors. Some announcements of planned action have been followed by sharp falls in share values; many shareholders have seen their holdings diluted by the creation of new preference shares in some cases held by the state; and there has been an absence of shareholder consultation and instances of unequal treatment (the U.S. government stepped in to save AIG from bankruptcy, but allowed Lehman Brothers to fail, and the U.K. government is procuring a merger between LloydsTSB and HBOS but has chosen to nationalise Northern Rock and Bradford & Bingley).
These and other issues raise the prospect of a wave of investor-state claims against governments based on the impact of the rescue packages. Many of the countries concerned have bilateral or multilateral investment treaties (known as BITs or MITs) in place intended to protect foreign investors from discrimination, unfair expropriation, and other state action. Unlike most international treaties, these investment treaties typically create a direct right of action on the part of investors that are nationals of one country against the other state party to the treaty. Such claims are typically administered by the International Centre for the Settlement of Investment Disputes (ICSID) or before bodies such as the International Chamber of Commerce (ICC), the London Court of International Arbitration (LCIA) or the Stockholm Chamber of Commerce (SCC).
Past economic crises have been the catalyst for a series of investor-state claims. More than 40 out of the 140 cases currently pending before ICSID arise out of the Argentinean government's responses to the financial crisis of 2001-2002. Those cases provide a guide to the types of measures that can ground an investment treaty claim and the defences that are likely to be relied on by a state. Foreign investors claimed compensation from the Argentinean state arising out of a variety of measures including the devaluation of the peso, the pesification of debt and the freezing of bank accounts. Many claims remain ongoing. Argentina has relied on two principal defences. One was the presence in the relevant BIT of a non-precluded measures (NPM) clause that limited the applicability of investor protections in exceptional circumstances, including the protection of essential security and the maintenance of public order. The second was the customary international law defence of necessity. Although all the tribunals to date have accepted that both defences can apply to measures taken to avert financial crises, most tribunals (notably those in the cases involving CMS, Enron and Sempra Energy) have interpreted those defences strictly and have awarded compensation to the claimant investor. Other tribunals, notably in the cases involving LG&E Energy Corp. and Continental Casualty, have recognised that the intent of the state parties to the treaties was to strike a bargain between increased investor protection and state policy flexibility, and accorded deference to a government's freedom of choice in regard to the methods used to avert a financial disaster.
It is of course too soon to assess precisely which states will face claims arising out of the current crisis and what kind of measures will generate claims. The scale of the economic crisis and the number of potential claims may cause governments to agree on a new structured process for the administration of claims, possibly including the establishment of a specialised tribunal or series of tribunals along similar lines as the U.S.-Iran Claims Tribunal. It is understood that intergovernmental discussions are already underway in this respect.
Whether claims are brought under the auspices of ICSID, before the ICC, LCIA or SCC or by means of a special tribunal established for the purpose, each case will of course turn on its facts and the interpretation of the relevant treaty, the measures adopted, and their precise financial impact on the individual claimants. The position is further complicated by the absence of a strict doctrine of precedent in treaty-based claims.
Explicitly or substantively discriminatory measures will provide the most obvious target. This would include measures such as the proposal by the Icelandic government to guarantee only those deposits in its banks held by Icelandic citizens or companies, which proposal was shelved following international diplomatic efforts. Yet as the Argentina cases show, macroeconomic policy instruments may also give rise to significant claims where they can be proved to have harmed non-national investors. This could include the obtaining of ownership or control of financial institutions, the dilution of shareholdings, and the triggering of stock value declines. In such cases, the approach taken by ICSID tribunals to NPM clauses in the relevant BITs and to the defence of necessity will be of central importance. Since this economic crisis is global rather than local, but each government faces unique challenges in its own economy, it is to be expected that the deferential approach taken in LG&E Energy Corp. and Continental Casualty will gain ground.
Individual or institutional investors who have been adversely affected by state actions during the current crisis should consider the possibility of mounting a claim under a relevant treaty made between a country to which they can claim nationality and the country in which their affected investment was located.
Posted on October 24, 2008 by K&L Gates
By David T. Case
The evolving efforts of the U.S. Government to address the turmoil in the financial markets echo in many respects Government actions to address the “crisis” in the savings and loan industry in the 1980s. As a consequence, the litigation against the Government resulting from the regulatory reform of the savings and loan industry provides a useful template in the event that the current reforms cause the Government to breach promises of specific regulatory treatment. In particular, under the previous litigation, the Government has been held liable for breach of contract, and substantial damages have been awarded, including damages for lost profits.
Looking back to the 1980s, regulators were faced with the possibility of widespread failure by savings and loans, along with a corresponding threat to the deposit insurance funds and potentially enormous liquidation costs. Many early efforts to solve the savings and loan crisis resulted in contracts between savings and loans and the Government in which the Government promised specific treatment under pertinent regulations. The Federal Savings and Loan Insurance Corporation (“FSLIC”) entered into varying forms of such agreements, either as a means of directly avoiding seizure of failing institutions, or indirectly avoiding such seizures by encouraging healthy thrifts to acquire failing institutions.
Subsequent efforts to resolve the savings and loan crisis culminated in the passage and implementation of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), and in implementing the provisions of that law, the Government breached many of its earlier promises. These breaches caused a wave of claims against the Government, and one critical lesson from the tumult is that contracts with the Government for specific regulatory treatment are enforceable, and the Government will be liable for damages caused by its breach of contract. The U.S. Supreme Court has held that, where the Government entered into contracts with regulated financial institutions, promising to provide financial institutions with “particular regulatory treatment in exchange for their assumption of liabilities that threatened to produce claims against the Government as insurer,” the risk of regulatory change fell to the Government, even though “Congress subsequently changed the relevant law, and thereby barred the Government from specifically honoring its agreements.” United States v. Winstar, 518 U.S. 839, 843 (1996).
The application of these principles was recently affirmed in a case presenting a scenario remarkably reminiscent of current Government attempts to address the turmoil in the financial markets: First Federal Savings and Loan Association of Rochester v. United States, 76 Fed. Cl. 106 (2007), aff’d 2008 U.S. App. Lexis 17331 (Aug. 13, 2008). Four failing savings and loans were merged into First Federal, and the Government provided financial assistance to the institution, replaced senior management, selected members of the Board of Directors, and exercised substantial control over First Federal’s operations.
First Federal later claimed that the Government had breached its contract with First Federal by failing to honor its agreement to allow First Federal to operate at reduced capital levels. The contract had been agreed to between First Federal and FSLIC as part of a reorganization of First Federal, and the agreement was intended to permit the Association to return to financial health as an alternative to seizure, following a lengthy period of insolvency, and to save FSLIC the costs of liquidating the Association. Following this 1986 agreement, First Federal’s business prospered until 1989, when Congress passed FIRREA, nullifying all contracts between the FSLIC and thrift institutions to the extent that those contracts relaxed regulatory capital requirements for specific thrift institutions.
Finding liability against the Government, the court awarded First Federal $85 million in damages, primarily for lost profits, plus attorney’s fees and costs. The award was recently affirmed by the United States Court of Appeals for the Federal Circuit. First Federal, 2008 U.S. App. Lexis 17331 (Aug. 13, 2008).
First Federal provides a roadmap for claims that arise as a result of the Government’s breach of contract, and if a financial institution believes it has such a claim against the Government, counsel should be consulted to evaluate appropriate steps to preserve and perfect the claim.
Posted on October 24, 2008 by K&L Gates
By Charles R. Mills and Lawrence B. Patent
The CFTC on October 2, 2008 published an interpretative statement providing that claims in the case of a futures commission merchant’s (FCM) bankruptcy related to over-the-counter (OTC) contracts that are not executed or traded on a designated contract market, yet are submitted for clearing through an FCM to a derivatives clearing organization (DCO), will be entitled to the same preferential treatment as customers whose claims are based solely upon exchange-traded futures contracts. The significance of the “customer” designation is that customers in a commodity broker bankruptcy are entitled to priority over all other claims except for those necessary for the administration of the bankrupt estate. This CFTC statement provides greater certainty that a party's commodity broker or FCM is now reduced as a credit risk even if only OTC contracts are involved, and is yet another example of the convergence of the OTC and exchange-traded worlds.
OTC parties treated like exchange-traded futures customers. To qualify for preferential treatment in an FCM bankruptcy, the person with the claim based upon the OTC contract must be considered to be a “customer” under the Bankruptcy Code and CFTC regulations thereunder, Part 190. A person will be considered to be the FCM’s customer if its claim arises out of a “commodity contract.” The CFTC interpretative statement says that OTC contracts that are “cleared-only” contracts are contracts for the purchase or sale of a commodity for future delivery within the meaning of the Bankruptcy Code and thus qualify as “commodity contracts,” making a party thereto a customer. The statement notes that, although the creation and trading of the OTC contracts is outside CFTC jurisdiction, the clearing of these products by FCMs and DCOs is within CFTC jurisdiction.
Alternative theory achieves the same result. The CFTC statement also presents an alternative method of finding that a party to a cleared-only OTC contract is an FCM’s customer, even if the OTC contract is not held to be a commodity contract. If the party has both cleared-only and exchange-traded futures contracts in its account with the FCM, the entirety of the account owner’s assets in that account serves as performance bond for each of the exchange-traded and OTC contracts pursuant to CFTC orders issued under Section 4d(a)(2) of the Commodity Exchange Act. Thus, a claim for those assets in bankruptcy constitutes a claim “on account of a commodity contract made, received, acquired, or held by or through [an FCM] in the ordinary course of [the FCM’s] business as [an FCM] from or for the commodity futures account of such entity,” which qualifies a person with such a claim as a customer of the FCM under the Bankruptcy Code. The CFTC statement further notes that the nature of futures trading makes it unwise to provide different treatment for an account that is currently portfolio margined among OTC and exchange-traded contracts and one that was at one time or is intended to be so in the future. There is no requirement that the customer’s assets are margining commodity contracts on the day that the bankruptcy petition is filed and all assets contained in the account are properly included in the customer’s net equity for purposes of making a claim.
Risk mitigation. The CFTC interpretative statement provides that parties to OTC contracts that clear, have cleared or intend to clear such transactions through an FCM’s Section 4d account at a DCO will be protected in the event of the FCM’s bankruptcy to the same extent as a customer of the FCM whose only transactions were exchange-traded futures. Although the DCO guarantee does not run directly to the customers of the clearing members, because of the way the system operates, no customer of a clearing member FCM has suffered financial loss due to the FCM's failure during the history of the Commodity Exchange Act, which dates to 1936. The segregation of funds system protects a customer from an FCM stealing its funds; the DCO guarantee protects from default by the other side of the trade. The treatment of an OTC contract party like any other customer if the FCM goes bankrupt will serve to protect the OTC party from fellow customers of the FCM, which have caused FCM bankruptcies in the past, when a fellow customer of the FCM defaults in such a massive way that the FCM becomes insolvent.
Posted on October 24, 2008 by K&L Gates
By Charles R. Mills and Lawrence B. Patent
Energy businesses and traders in energy futures markets should be aware that the Federal Trade Commission (FTC), acting under authority granted in last year’s energy bill, proposed a new anti-manipulation rule in August that would prohibit the use of manipulative or deceptive devices or contrivances in wholesale crude oil, gasoline or petroleum distillate markets. The FTC states in the Federal Register notice announcing the proposals that its rules in this area are modeled on SEC Rule 10b-5. The FTC thus would become part of the posse of federal agencies searching for villains to blame for the run-up in energy prices earlier this year. The FTC is taking this action despite the fact that, in response to its Advance Notice of Proposed Rulemaking in this area, even very few consumer commenters supported an FTC anti-manipulation rule.
No safe harbor for futures traders. Despite comments on an Advance Notice of Proposed Rulemaking that a safe harbor provision or other explicit exemption for the futures markets is necessary to avoid overlap with CFTC (Commodity Futures Trading Commission) jurisdiction over futures markets, the FTC does not believe that a safe harbor or exemption is warranted. Although the FTC points to its prior practice of coordinating enforcement efforts with other agencies, the CFTC has continued to urge the FTC to reconsider its opposition to a carve-out of the futures markets from the FTC’s rule. The extended comment period on the FTC’s proposed rule closed on October 17, 2008, and the FTC has scheduled a public workshop on the proposals for November 6, 2008.
Are three heads better than one? Energy businesses and futures traders may need to be mindful of the FTC in addition to the CFTC and the Federal Energy Regulatory Commission (FERC). The CFTC and FERC continue to debate their respective jurisdictions over energy futures markets, which has been highlighted by the agencies separately bringing competing enforcement actions against the now-defunct hedge fund Amaranth Advisors, LLC with respect to its trading in the natural gas futures market.
Posted on October 6, 2008 by K&L Gates
By: Daniel F. C. Crowley, Patrick G. Heck
Recent Policy Responses
The recent public policy responses to the credit crisis have been geared toward restoring liquidity in the credit markets, enhancing transparency, and prohibiting certain trading practices. Foremost among these measures has been H.R. 1424, the Emergency Economic Stabilization Act of 2008 (“EESA” or “the Act”), in response to the Department of the Treasury’s (“Treasury”) request for authority to spend up to $700 billion to purchase illiquid assets. The Act is intended to improve the capital positions of financial institutions and allow them to once again extend credit. Other stop-gap measures by the regulatory agencies, as discussed elsewhere in this newsletter, have been geared toward reducing volatility and restoring orderly markets.
EESA, which was passed by the House and signed by President Bush on Friday, October 3, 2008, authorizes up to $700 billion for the Treasury for a troubled asset relief program (TARP) to purchase, and a Troubled Assets Insurance Financing Fund to insure, illiquid financial instruments. The Act allows Treasury to immediately use $250 billion, with an additional $100 billion if the president certifies such a need. The president would have to provide a written request for the remaining $350 billion, which could be subject to expedited congressional approval.
The Act
- Creates the Financial Stability Oversight Board, comprised of the Fed Chairman, the Secretaries of Treasury and HUD, the FHFA Director, and the SEC Chairman.
- Creates various reporting and oversight requirements.
- Waives FAR and provides for streamlined contracting procedures.
- Establishes a Congressional Oversight Panel in the legislative branch to “review the current state of the financial markets and the regulatory system.”
- Places limits on senior executive compensation for some participating financial institutions.
- Requires Treasury to develop programs to reduce foreclosures and encourage lenders to modify mortgage terms.
- Prohibits use of the Exchange Stabilization Fund for future money market guarantee programs.
- Authorizes the SEC to suspend mark-to-market accounting (FAS 157).
- Increases the federal budget debt ceiling to $11.315 trillion.
- Temporarily increases the FDIC insurance limit from $100,000 to $250,000.
The text of the Act and a section-by-section analysis may be found on the House Financial Services Committee website: http://financialservices.house.gov/.
EESA Tax Provisions
EESA also contains a number of important tax provisions that have not received a great deal of attention. There are three tax provisions related to the rescue plan:
- Extension of exclusion of income from discharge of qualified principal residence indebtedness. Generally, when homeowners have parts of their mortgages forgiven, they immediately owe income taxes on the amount of indebtedness forgiven. To prevent homeowners from facing higher tax bills, the housing relief bill passed by Congress earlier this year allowed homeowners caught up in the mortgage crisis to avoid paying tax on forgiven mortgage debts through 2009. EESA will extend through 2012 the housing bill provision that forgives income from the cancellation of indebtedness. The proposal does not extend the relief to home equity loans. The Joint Committee on Taxation estimates that this provision will cost $362 million over ten years.
- Gain or loss from sale or exchange of certain preferred stock. Federal law limits the allowable investments for banks, and many community banks therefore invested in Fannie Mae and Freddie Mac preferred stock – which became worthless when the government bailed out those companies. EESA includes a proposal to allow financial institutions or financial institution holding companies to treat their Fannie and Freddie losses as ordinary losses. Applying to any preferred stock that was owned on September 6, 2008 or sold between January 1 and September 6, 2008, this provision will allow banks to claim the book benefit of the loss on their tax returns, therefore reducing the need to obtain additional capital from the FDIC or investors. Policy makers believe that this proposal should also prevent some community banks from becoming insolvent. The Joint Committee on Taxation estimates that this provision will cost $3.045 billion over ten years, with $2.7 billion of the cost occurring in 2009.
- Special rules for tax treatment of executive compensation of employers participating in the troubled assets relief program. The EESA contains non-tax measures aimed at limiting executive compensation and “golden parachute” severance packages overall for companies and executives participating in the buyout. Additionally, EESA modifies the tax treatment of executive compensation and severance packages. The deductibility of executive compensation for companies participating in the troubled asset relief program will be cut in half – from the $1 million level in current law – to $500,000. Performance-based compensation is included in the $500,000 limitation. Companies will also lose deductions currently available for excessively large severance packages. Executives receiving severance packages will continue to face a 20 percent excise tax on payments once they reach an excessive threshold, and that tax will now be due if the executive leaves for reasons other than a standard retirement for which they are eligible – not just if the company changes hands, as in current law. The Joint Committee on Taxation estimates that the amount of revenue gain from these provisions is indeterminate as it will depend on how the underlying troubled asset program is implemented.
In addition, the Act extends dozens of expired or expiring tax provisions (the so-called “tax extender package”), including the Alternative Minimum Tax and disaster relief, energy tax incentives and a host of other provisions. Several of these provisions might be of interest to the financial services community. For example, the package includes: 1) broker reporting of a customer’s basis in securities transactions; 2) an extension of tax-free distributions from IRAs to certain public charities through 2009; 3) an extension of the exception under Subpart F for active financing income through 2009; 4) an extension of the look-through treatment of payments between related CFCs under foreign personal holding company income rules; and 5) the modification of the tax treatment of offshore nonqualified deferred compensation for certain tax indifferent parties. The package does not include a further delay in the implementation of the worldwide interest allocation rules.
Finally, in addition to the various tax provisions listed above, the package contains a provision that would lower the tax preparer standard for undisclosed positions from “more likely than not” to “substantial authority” (the same standard that currently applies to taxpayers) with the exception for tax shelters (reportable transactions to which section 6662A applies).
The Long View
In the slightly longer term, these unprecedented market events will likely lead to the most significant revisions to the legal and regulatory framework for financial services since the Great Depression.
- Revamping the structure of financial services regulation. Beginning in January 2009, the 111th Congress will consider comprehensive legislation to restructure the regulation of financial services. A primary consideration will be the respective roles of the Treasury, the Federal Reserve Board, the SEC and the CFTC with respect to oversight of the capital markets. Some of the proposals under consideration were outlined in the Treasury’s March 2008 “Blueprint for a Modernized Financial Regulatory Structure.”
- Regulation of previously unregulated products and entities. Current discussions also include new reporting and other regulatory requirements for a broad array of financial products and market participants that have, until now, been subject to relatively little regulation, including commodities, derivatives, hedge funds and sovereign wealth funds. Some products that currently trade over-the-counter may soon be required to trade on exchanges and, more generally, all market participants with the potential to impact the economy will almost certainly be under increased scrutiny.
- Among the other issues that will likely be considered as part of this comprehensive reform effort are:
- Credit rating agency reforms,
- Enhanced government agency enforcement authorities, and
- Recommendations of the Congressional Oversight Panel created by EESA.
- Tax. With respect to federal tax issues relating to investments, determination of the appropriate tax rates on capital gains and dividends and the appropriate tax treatment of derivatives, as well as retirement savings incentives, will receive considerable attention.
- Retirement Plans. Finally, there will almost certainly be a renewal of efforts to increase disclosure with respect to defined contribution plan fees.
Our Public Policy & Law group is closely monitoring these developments in order to provide insights to and effective advocacy on behalf of firm clients.
Posted on October 6, 2008 by K&L Gates
By: Arthur C. Delibert
Recent turmoil in the securities markets, affecting financial companies in particular, has imposed unprecedented stress on money market funds, as some institutional investors have sought to liquefy their holdings at the very moment that many money funds have found it difficult to raise cash. These pressures have resulted in some extraordinary market and regulatory events. Illustrative of the pressures facing the industry and regulators:
- On September 16, The Primary Fund, a money market series of The Reserve Fund, announced that it had “broken the dollar” – i.e., that the mark-to-market value of its portfolio assets had fallen below $0.995 per share. (LINK) In fact, the fund said, its per-share net asset value had fallen to 97 cents, primarily from holding paper issued by Lehman Brothers, which had filed for bankruptcy on September 15. This is only the second time a registered money fund has broken the dollar, the last such event having occurred in 1994. (Reserve has subsequently reported that the assets available may be higher than 97 cents per share.)
Subsequently, Ameriprise Financial Services filed suit against The Reserve Fund and its manager, alleging that certain large investors had been tipped off about the Fund’s impending problem, allowing those investors to remove their money before the NAV was reduced.
- On September 18, Putnam Investments announced that it was suspending sales of its institutional Putnam Prime Money Market Fund and would liquidate the fund. Within days, Putnam and Federated Investors, Inc. announced that Federated Prime Obligations Fund would acquire the assets of the Putnam money fund and that all shareholders would receive shares of the Federated fund worth $1.00 per share.
In the face of these pressures, many money funds have resorted to extraordinary measures:
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Many funds have drawn on lines of credit previously arranged through their custodian banks and others. The Federal Reserve made extra cash available to these banks to fund the loans.
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Some funds have made use of their authority under Section 22 of the 1940 Act to withhold payment on redemption orders for up to seven days, rather than the same-day or overnight payment offered in fund prospectuses “under normal circumstances.” Such extensions can be difficult for customers, who expect to have prompt access to assets held in money funds.
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Other funds have used authority reserved in their prospectuses to pay redemptions through the in-kind distribution of portfolio securities. These distributions potentially raise two questions under the 1940 Act:
- Funds may have filed with the SEC irrevocable elections under Section 18 of the 1940 Act, allowing them to make redemptions in kind for shareholders seeking redemptions in excess of $250,000 or 1% of the fund’s net assets, whichever is less, in any 90 day period, but committing them to pay lesser redemptions in cash. Such filings have become less common since 1996, meaning that some funds have greater flexibility in this area.
- Redemptions paid in kind to shareholders that are affiliates of the fund because they hold 5% or more of the fund’s outstanding securities may raise questions under Section 17 of the 1940 Act, which restricts principal transactions with affiliates. Funds can rely on a 1999 no-action letter issued by the SEC staff, which permits in-kind payments to affiliates provided the fund’s board either approves the transaction or has adopted certain procedures to assure the fairness of such distributions.
There have also been extraordinary actions from the regulators:
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Some money funds have sought permission from the SEC under Section 22(e) of the 1940 Act to suspend redemptions. On September 22, the SEC issued an order (effective as of September 17) authorizing two Reserve Funds to suspend redemptions for an indefinite period, while they engage in an orderly liquidation. (
LINK)
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On September 19, the Federal Reserve temporarily exempted member banks from provisions of the Federal Reserve Act to permit the banks to purchase asset-backed commercial paper from affiliated money market funds. (
LINK)
On September 25, the SEC staff issued a no-action letter permitting such purchases. Such purchases by fund affiliates would normally raise issues under Section 17 of the 1940 Act. Rule 17a-9 permits fund affiliates to purchase securities from money market funds if they are no longer “eligible securities” under Rule 2a-7 – i.e., if they have deteriorated in quality. The no-action letter permits such purchases even if the security is still eligible.
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On September 19, the Treasury announced a program of money market fund insurance. Funds wishing to apply for the insurance must do so by Wednesday, October 8. (
LINK)
According to the announcement, Treasury is establishing this program under existing authority, using the $50 billion Exchange Stabilization Fund. Treasury’s authority may be limited somewhat by the Economic Stabilization Act which, as of this writing, is still under consideration by Congress. The insurance initially will be available for a period of three months, at which point Treasury may renew it for a total period of up to a year, but participating funds would be required to pay an additional fee.
The insurance applies only to assets in a fund on September 19, the day the program was announced. This limit was apparently adopted at the urging of the banking industry, which was concerned that if money fund insurance were available for unlimited amounts of new assets flowing into the funds, large deposits would flee the banks. The program is available only to funds registered under both the 1933 Act and the 1940 Act.
Funds wishing to apply to the program must obtain approval of their boards of directors, as the application requires that the board, including a majority of independent directors, determine that “entering into” the Guarantee Agreement, as well as “fulfillment of its obligations … are in the best interests of the Fund and its shareholders.” Fund boards must take into consideration a number of factors before entering into such an Agreement.
Posted on October 6, 2008 by K&L Gates
By: Kay A. Gordon, Mark D. Perlow
In response to the recent extraordinary events in the U.S. and worldwide markets, during the past two weeks the Securities and Exchange Commission (“SEC”) adopted a series of emergency regulatory measures regarding short sales of securities. First, on September 17 and 18, 2008, the SEC issued orders temporarily banning short sales in certain financial stocks and requiring certain institutional money managers to report their new short sales of certain publicly traded securities on new Form SH (collectively, the “Emergency Orders”). The SEC also amended Regulation SHO and Rule 10b-18 under the Securities Exchange Act of 1934 to prohibit “naked” short selling—the short sale of securities that one has not already borrowed—and adopted a new antifraud rule, Rule 10b-21, aimed at manipulative and deceptive practices in short selling. In addition, the SEC chairman announced enforcement initiatives aimed at preventing “naked” and “manipulative” short selling. The SEC has taken these actions in the hope that they would help to restore fair and orderly markets and curtail declines in securities prices. On October 1, the SEC extended all of these emergency measures until October 17. However, the ban on selling certain financial stocks provided that it would expire after the effectiveness of the EESA. Therefore, the ban expires on Wednesday October 8 at 11:59 p.m.
On September 21, the SEC amended the Emergency Orders to expand (1) the list of issuers in whose securities the SEC has temporarily banned short selling, (2) the scope and duration of certain market maker exceptions, and (3) the types of securities exempted. The SEC also stated that institutional investment managers’ short sale disclosures would be non-public for two weeks after filing. The SEC adopted these amendments to address the current and anticipated technical and operational issues raised by the Emergency Orders, as well as to coordinate with similar actions restricting short sales by foreign regulators.
In addition to the actions of the SEC, the U.K. Financial Services Authority and the French, German, Australian and many other regulators have adopted similar restrictions on short selling and, in certain cases, increased short selling disclosure requirements in an effort to restore market integrity and stability in these extreme market conditions. Consequently, the policy level response to the perceived threat and the uncertainty generated by naked short selling was global, if not globally coordinated, in practice making it difficult for any manager to engage in forum shopping.
Many financial institutions, lawmakers and regulators have supported the SEC’s ban and limits on short sales, based on their concern that short sellers have contributed to the current market turmoil by spreading false information and using manipulative trading tactics. In contrast, many hedge fund managers and other investors have objected to these measures, suggesting that risk management failures and poor business strategies are to blame for the current market instability. They have argued that short selling provides liquidity and an important price discovery mechanism in the market and that the inability of managers to engage in short selling with respect to certain securities may adversely affect the markets both in the long and short terms. Critics of the ban also point out that a temporary SEC order banning naked short selling in July failed to prevent the decline of stock prices while it was in effect.
The increased disclosure obligations have also given rise to concerns that managers will have to disclose proprietary methods and that companies whose securities are being sold short would retaliate against these managers when the managers’ short positions are publicly released. The short selling ban may have also been particularly damaging to certain quantitative funds, which were left unable to implement their disclosed and intended strategies. In addition, short sellers were also constrained on another front: many institutional investors that lend portfolio stock holdings have been recalling their stock, and some have suspended their stock lending programs altogether, which has made it harder or more expensive to borrow certain stocks. Some industry participants believe that short sellers will adjust to the ban by switching to other instruments that are not subject to the ban, e.g., single stock futures and options, whose price movements will ultimately be reflected in the prices of the affected stocks.
Posted on October 6, 2008 by K&L Gates
By: Brian A. Ochs
On September 19, 2008, the SEC announced a “sweeping expansion” of its ongoing investigation into possible market manipulation in connection with short selling in the securities of financial institutions. (LINK) The investigation is focused on broker-dealers, hedge fund managers, and institutional investors with significant trading activity in financial issuers and with positions in credit default swaps.
As part of the investigation, the SEC is invoking its authority under section 21(a) of the Securities Exchange Act of 1934 to require certain information in the form of sworn, written statements. According to published reports, the first of these demands was sent out on September 22 to more than two dozen hedge fund managers, requiring information relating to AIG, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Washington Mutual. The SEC seldom invokes its section 21(a) power in enforcement investigations — usually opting to subpoena documents and testimony instead — and the fact that the Commission is doing so in this instance indicates the speed and seriousness with which the SEC plans to pursue these investigations.
The SEC’s expanded investigation promises heightened scrutiny of two issues which have been the subject of enforcement focus since early this year: the dissemination of false rumors to the marketplace as part of short selling schemes and abusive “naked” short selling.
- False rumors and short selling
- Last April, the SEC brought its first case alleging that a trader engaged in market manipulation by selling a company’s stock short at the same time that he intentionally disseminated a false rumor that had a depressing effect on the stock price. See SEC v. Paul S. Berliner (April 24, 2008). (LINK) Other investigations are in progress, as well as an industry-wide sweep examination undertaken in conjunction with FINRA and the NYSE, that is focused on whether broker-dealers and investment advisers have reasonable controls and procedures to prevent the intentional creation or dissemination of false information. (LINK)
- Given the prevalence of rumors of all types in the investment community, and how quickly rumors can spread, a key challenge to the SEC in any investigation will be to determine who is responsible for disseminating false rumors and whether those persons acted intentionally and with knowledge that the rumors were false.
- At the same time, the SEC’s focus on firm procedures indicates that the SEC will be looking to bring enforcement actions not only against individuals who are responsible for creating or disseminating false rumors, but also against any broker-dealers or investment advisers in the rumor chain that the SEC determines had lax oversight.
- Complicating matters is the fact that, on September 18, New York Attorney General Andrew Cuomo announced his own investigation into allegations of short selling in financial securities based upon false information. NYAG involvement not only increases pressure on the SEC to bring cases in this area, but is also a direct and formidable threat to the individuals and entities under scrutiny. Unlike SEC Enforcement staff, New York’s Assistant Attorneys General have considerably fewer levels of bureaucracy to wind through before they can bring a case - as they have repeatedly demonstrated in matters involving market timers, insurance brokers, lenders, ratings agencies, and purveyors of auction-rate securities, to name a few. Contrary to popular belief, Section 352 et seq. of NY General Business Law (aka the “Martin Act”) is not without its jurisdictional limitations and defenses, but it is nonetheless a potent starting point for the NYAG. Subpoenas issued thereunder must be handled with considerable caution.
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“Naked” short selling
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SEC Chairman Christopher Cox has observed that naked short selling can “turbocharge” false rumor/manipulation schemes. (
LINK)
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On September 18, 2008, the SEC adopted Rule 10b-21, which had been proposed in March 2008 to address the problem of short sellers who deceive broker-dealers or others about their intention or ability to deliver securities in time for settlement. (
LINK) The rule formed part of the SEC’s response, in the current financial crisis, to concerns about possible false rumors and abusive naked short selling of financial institutions and other issuers.
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Rule 10b-21 prohibits any person from submitting an order to sell an equity “if such person deceives a broker or dealer, a participant of a registered clearing agency, or a purchaser about its intention or ability to deliver the security on or before the settlement date, and such person fails to deliver the security on or before the settlement date.” (
LINK)
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In adopting the rule, the SEC noted that while, in its view, naked short selling as part of a manipulative scheme was already prohibited under general antifraud provisions, Rule 10b-21 is intended to highlight the specific fraud liability of persons who deceive other participants about their intention or ability to deliver securities in time for settlement.
Of course, when short selling is facilitated by deceptive practices – such as intentionally spreading false rumors or misleading other participants about an intention to deliver stock – there is little doubt that the SEC can bring a case for securities fraud. Another example of deceptive practices might be the use of nominee accounts or similar efforts to disguise the identity of the short seller. But what if short selling is done in the open, with no accompanying acts of deception, albeit in large amounts and with the intent to drive a company’s stock price down?
- The SEC takes the position that even open trading, when done for a manipulative purpose (so-called “open market manipulation”), is fraudulent. See, e.g., SEC v. Masri, 523 F. Supp. 2d 361 (S.D.N.Y. 2007). Thus, the Division of Trading and Markets has cautioned that “short sales effected to manipulate the price of a stock are prohibited” as an “abusive” short sale practices. (LINK)
- Courts have taken varying positions on whether “open market manipulation,” without other deceptive conduct, can give rise to a cause of action. However, in a recent opinion dealing with aggressive short selling by purchasers of “toxic convertible” securities, the U.S. Court of Appeals for the Second Circuit held that “short selling – even in high volumes – is not, by itself manipulative. … To be actionable as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security.” ATSI Communications, Inc. v. Wolfson, 493 F.3d 87 (2d Cir. 2007).
Given the Second Circuit precedent, in any future cases directed at aggressive short selling, the SEC will likely seek to allege other deceptive conduct in addition to short sales. However, in light of the SEC’s need to demonstrate a strong response to the current crisis, the Commission can also be expected to press its theory that short selling, even if unaccompanied by any other deceptive practices, is unlawful if done for the purpose of depressing a company’s stock.
Posted on October 6, 2008 by K&L Gates
By: Gordon F. Peery
When Fannie Mae and Freddie Mac were placed into conservatorship on September 7, 2008, several leading dealers uncontroversially agreed that a bankruptcy credit event had occurred on credit derivative transactions referencing either of those institutions. The occurrence of a credit event gave protection buyers the right to settle the transaction in exchange for a payment to compensate it for the loss of market value of specified deliverable obligations of the reference entity. As it has done in the case of previous credit events on widely traded reference entities, the International Swaps and Derivatives Association (“ISDA”) has introduced an auction protocol to facilitate settlement of transactions by providing for cash settlement as an alternative to physical settlement.
A controversy arose over whether the principal-only component of debt securities issued by Fannie Mae and Freddie Mac (“PO Strips”) should be included in the list of deliverable obligations that could be valued for purposes of settlement. This was an important issue for transaction counterparties because the buyer of protection on a credit default swap has no obligation to mitigate loss and is entitled to select the qualifying obligations that are “cheapest to deliver,” i.e., that have fallen most in value. Unusually for a reference entity’s obligations following a credit event, most Fannie Mae and Freddie Mac debt obligations traded at or above par after the credit event occurred when it became clear that the United States would guarantee all debt securities of Fannie Mae and Freddie Mac on an equal basis.
Protection buyers would have benefited from the inclusion of PO Strips in the list of deliverable obligations because those obligations continued to trade below par following the credit event, reflecting that the market value of stripped securities depends not only on the issuer’s perceived creditworthiness but also on broader market factors such as interest rates and inflation. On cash settlement of a credit derivative transaction, a protection buyer would have been entitled to receive a payment equal to the difference between the notional amount of the transaction and the market value of the PO Strip selected for valuation. ISDA’s board of directors concluded that Fannie Mae and Freddie Mac PO Strips cannot be delivered in settlement of credit derivative transactions because they do not technically constitute “borrowed money” as defined in the 2003 Credit Derivatives Definitions. This conclusion is based in part on the fact that as a stripped security a PO Strip represents only part of a repayment obligation, and is also based on the conclusion that a PO Strip is not issued as a “bond” or “note” by the relevant issuer but is rather a product of the book-entry rules for obligations of each GSE in book-entry form on the Federal Reserve Banks’ book-entry system because the stripping of debt securities into interest and principal components occurs after their “issuance.”
Insurance Regulatory Developments Affecting Credit Derivatives
On September 22, 2008, the New York State Department of Insurance issued Circular Letter No. 19, which sets forth best practices for financial guarantee insurers. Circular Letter No. 19 announced new guidelines that, for the first time, will establish that some credit default swaps that have previously not been subject to state regulation as insurance products will be deemed to constitute “the doing of an insurance business” within the meaning of Section 1101 of the New York Insurance Law. The new guidelines, which will be effective January 1, 2009, establish that a credit default swap will be considered an insurance contract when the buyer owns or is reasonably expected to own the reference obligation. In essence, a party who owns the reference obligation for a credit default swap will be presumed to have entered into the transaction in order to obtain indemnification for loss on that obligation. Under the new guidance, credit default swaps would be subject to regulation and will be issuable only by entities licensed to conduct insurance business. The guidance does not extend to so-called “naked swaps,” which are not insurance and cannot be regulated by state insurance authorities.
Posted on October 6, 2008 by K&L Gates
By: Mark D. Perlow
On September 30, the SEC Office of the Chief Accountant and the FASB staff provided guidance on fair value under FAS 157, addressing when internal assumptions can be used to measure fair value, when to use broker quotes, and when transactions in disorderly or inactive markets represent fair value. FAS 157, which became effective in November 2007, defines fair value as the price that would be obtained in an orderly transaction between market participants in the principal or most advantageous market.
The SEC’s guidance came in response to banking industry complaints that the emphasis under FAS 157 on such market valuations for financial assets was forcing banks to write down performing assets to “fire sale” or distressed prices, compelling them to sell more assets to raise capital and thereby depressing prices further in a downward spiral. Many supporters of FAS 157, including investors’ groups, expressed the view that market values gave a more accurate picture of the health of financial institutions than values based on cost or cash flow models.
The SEC rarely involves itself in FASB policy making, and its action is clearly an attempt to reach a compromise between the two positions: the SEC relaxed the interpretation of some of FAS 157’s market valuation provisions but did not suspend market valuation, as some have requested.
Some of the key elements of the SEC/FASB guidance are:
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Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence. Unfortunately, the only further guidance that the SEC and the FASB give is that “determining whether a particular transaction is forced or disorderly requires judgment.” However, by placing this determination in the realm of judgment, the SEC can still second-guess the firm that follows in good faith a strong, well-documented, consistent and independent process.
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FAS 157 sets forth a three-tier framework for disclosure of fair values, where Level 1 prices derive from trades in an active market, Level 2 prices derive from observable inputs, or prices in related markets, and Level 3 prices derive in part or whole from unobservable inputs such as models. The SEC’s guidance states that, in some cases, using internal assumptions and unobservable inputs (e.g., an internal discounted cash flow model) may be more appropriate than using observable inputs (e.g., prices in markets for similar but not identical securities). For instance, if the observable inputs (say, prices in related markets) require too many adjustments and the internal model is more accurate, under the guidance the Level 3 price would be more appropriate. Before the SEC’s guidance, many market participants interpreted this disclosure hierarchy as implying that Level 3 prices were less appropriate than Level 2 prices.
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Broker quotes are not necessarily fair value if there is no active market in the security, defined as a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
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A significant increase in the bid-ask spread or the existence of a relatively small number of bidders are indicators that may suggest that a market is inactive.
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Broker quotes based on models warrant less weight than those based on market transactions.
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Whether a broker is giving an “accommodation” quote (i.e., one not binding on the broker) “should be considered”, which probably means that such quotes deserve less weight in pricing judgments.
Posted on October 6, 2008 by K&L Gates
By: Edward G. Eisert, Rebecca H. Laird
On September 22, 2008, the Board of Governors of the Federal Reserve issued a new policy statement on equity investments in banks and bank holding companies (the “Policy Statement”). The Policy Statement was widely seen as a response to complaints by private equity firms seeking to make recapitalizing equity investments in troubled banks that the existing guidelines posed too great a risk of subjecting them to regulation as bank holding companies. In certain respects, the Policy Statement liberalizes and clarifies the guidelines that the Federal Reserve has applied since 1982 in determining whether a company controls a bank, bank holding company, or whether a bank or bank holding company controls another company such as a non-banking firm. At the same time, the Policy Statement reemphasizes the Federal Reserve’s belief that whether an investor has a controlling influence over a banking organization or a non-banking firm depends on all of the facts and circumstances of each case.
The primary indicia of control addressed in the Policy Statement are: (1) director representation (one and, in some cases, two directors, would be permissible); (2) total equity (in some cases up to one-third of total equity would be permissible); (3) the extent and subject matter of consultation with management (for example, advocacy regarding strategic decisions is permitted, but not “if accompanied by explicit or implicit threats to dispose of shares in the banking organization or to sponsor a proxy solicitation as a condition of action or non-action by the banking organization or management”); (4) business relationships (relationships are permitted that are “quantitatively limited and qualitatively nonmaterial, particularly in situations where an investor’s voting securities percentage in the banking organization [is] closer to 10 percent than 25 percent”); and (5) and the existence of covenants granting the investor approval or veto rights with respect to strategic decisions and management (“covenants that substantially limit the discretion of a banking organization’s management over policies and decisions suggest the exercise of a controlling influence”).
Despite its helpful guidance, the Policy Statement does not eliminate the concerns of private equity firms and other investors that wish to take larger equity stakes in, and have greater influence over, banking organizations than permitted under the prior guidance. For example, without more, there is a significant risk that a minority investor could be deemed to control a banking organization if it holds the largest percentage of equity, particularly if its combined ownership of voting and non-voting stock exceeds twenty-five percent. Private equity firms also must consider whether the greater latitude provided by the Policy Statement does, in fact, provide sufficient comfort (absent consultation with the Federal Reserve) for them to increase their targeted equity stake and board representation in a banking organization, particularly if their investment programs contemplate having significant influence over corporate strategies and material business decisions.
Posted on October 6, 2008 by K&L Gates
By: Edward Smith
On September 15, 2008, Lehman Brothers and its UK subsidiaries — Lehman Brothers International (Europe), Lehman Brothers Ltd, LB Holdings PLC, and LB UK RE Holdings Ltd — declared bankruptcy. On the same day, partners in PricewaterhouseCoopers LLP were appointed joint administrators of the UK entities.
The administrators' role will be to wind down the UK Lehman companies in an orderly manner. Administration is a procedure intended to either rescue an insolvent company or to realise a better value from its assets than on a liquidation. To do so, the administrators will take over the running and management of the companies. Administration introduces a statutory moratorium, or stay. This means that no action can be taken or continued against the companies or their property, without the consent of the administrators or the leave of the Court. Importantly, contractual set-off and close-out netting provisions will not be affected by the moratorium.
Administration does not, in itself, terminate contracts to which the Lehman entity is party. However, contracts may contain automatic insolvency termination clauses which permit the counterparty to terminate the contract on insolvency or the appointment of an administrator.
Many of Lehman’s prime brokerage clients have tried to terminate their prime brokerage agreements ("PB Agreements") in order to crystallise their position and gain some certainty. However, the standard Lehman documentation is one-sided and, in many cases, does not permit the client to terminate on Lehman insolvency or default. Equally, the close-out provisions may favour the Lehman entity — the client may not be entitled to exercise set-off unless and until all amounts owing to the Lehman entity have been settled.
In many cases PB clients have transferred collateral (in the form of cash or securities) to the Lehman entity. Many of the PB Agreements that we have reviewed provide that title to collateral passes to the Lehman entity and permits the Lehman entity to charge, transfer or sell the collateral. Any requirement to treat the collateral as "client money", in accordance with FSA rules, has usually been waived. In such cases, it is likely that the client has given up its proprietary rights in the collateral. Instead it will only have an unsecured claim in the administration for delivery of collateral “equivalent” to the original collateral. The value of the client's unsecured claim will depend on how much money is ultimately available for distribution. In some circumstances clients may be entitled to lodge a claim for compensation with a statutory fund. However, the tests for eligible applicants are prescriptive and the maximum amount of compensation is relatively small.
As a result, many PB clients have found that their assets are tied up at a Lehman entity and can only be claimed through the administration process. If, however, a Lehman entity has provided custodial services to a PB client, the client has a priority claim on those assets, and steps can and should be taken to contact the administrators to procure the return of the client’s assets.
Posted on October 6, 2008 by K&L Gates
By: Charles R. Mills, Lawrence B. Patent
Responding to Congressional pressure to improve the transparency of futures market activity of swap dealers and index traders, the CFTC will be issuing rule proposals that could, among other things, increase swap dealers’ futures trading reporting obligations and impose new terms for them to qualify for exemptions from regulatory limits on the number of futures positions they may hold. The proposals are intended to effectuate recommendations contained in a CFTC staff report released September 11, 2008, including the following:
- CFTC to separately report swap dealer futures position. The CFTC issues a weekly Commitments of Traders Report, which provides a breakdown of each Tuesday’s open interest for futures markets in which 20 or more traders hold futures positions required to be reported by CFTC rules. This information is currently sorted into categories of “commercial” and “non-commercial” traders, with swap dealers’ futures transactions included in the “commercial” category. The anticipated rule proposal would for the first time report swap dealers under a separate “swap dealer” classification.
- Swap dealers may be required to report client information. One of the provocative, albeit still opaque aspects, of the rulemaking will be to propose the creation of a supplemental CFTC market report that will disclose information regarding the particular types of trading by the swap dealers’ counterparties.
- The staff describes the contemplated report as one designed to “look through from swap dealers to their clients and identify the types and amounts of trading occurring through these intermediaries, including index trading.” Details about the scope, content and source of information for the supplemental report must await the CFTC’s proposing release, but the descriptions in the staff report suggest that swap dealers may be required to gather and report discrete information about the relationship between the swap transactions and the counterparties’ futures market positions.
- This could put swap dealers in the perhaps undesirable position of requiring clients to disclose to them otherwise sensitive, confidential proprietary trading information that clients would not otherwise disclose. It also would create a seemingly incongruous regimen that makes entering into swap transactions that otherwise are fully excluded from the reach of the Commodity Exchange Act a triggering event for gathering and reporting on clients’ futures market positions, at least on an aggregate basis.
- Changes to the hedge exemption for swap dealers. The CFTC also instructed the staff to develop an advance notice of proposed rulemaking to solicit comments on whether the current exemption from regulatory limits on the number of open futures contracts a trader may hold that is accorded to hedge positions should be eliminated for swap dealers and replaced with something different. The CFTC will solicit comment regarding whether exemption from position limits for swap dealers should be governed by a new “risk management” exemption that would require a swap dealer to agree to:
- report to the CFTC and applicable self-regulatory organizations whenever certain “non-commercial” swap clients reach certain position levels in related exchange-traded futures contracts and/or
- certify that none of a swap dealer’s “non-commercial” swap clients exceed specified position limits in related exchange-traded contracts.
This proposal, too, could be problematic for swap dealers by making them the “cop on the block” to police their clients’ futures positions, even when the swap dealer does not carry those positions for the client and does not otherwise have independent access to the information.
Posted on October 6, 2008 by K&L Gates
The United States Court of Appeals for the Second Circuit held that the National Bank Act (“NBA”) limits the ability of states to regulate tax preparers that facilitate tax refund anticipation loans (“RALs”) for national banks. The decision in Pacific Capital Bank, N.A. v. Blumenthal is of particular interest to any federally regulated lender (national bank, federal savings association, or operating subsidiary of either) that relies on third party agents (including brokers) to source loans or other bank products.
At issue was a Connecticut statute that capped interest rates on RALs. National banks were exempt from the law by its terms (and federal law would have preempted it for national banks anyway), but the Connecticut Attorney General concluded in a legal opinion that a tax preparer or other party that facilitated an RAL with an interest rate in excess of the statutory cap violated the statute, even if the lender was a national bank.
The court held that federal law preempted the interest rate limitation for facilitators of RALs made by national banks, at least in connection with RALs made through the arrangement at issue in the case, finding that “the natural effect” of enforcing the interest rate limits against facilitators that assist national banks offering RALs “would . . . be either to prevent a facilitator from assisting such national banks with respect to RALs or to cause it to refuse such assistance unless the national banks agreed to forgo their NBA-permitted rates and limit themselves to the lower rates specified by” the Connecticut law. The court concluded that “[i]f a state statute subjects non-bank entities to punishment for acting as agents for national banks with respect to a particular NBA-authorized activity and thereby significantly interferes with national banks’ ability to carry on that activity, the state statute does not escape preemption on the theory that, on its face, it regulates only non-bank entities.”
The court’s reasoning could extend past the RAL context to other situations where states try to regulate parties that arrange loans for federally regulated lenders. For example, this decision calls into question whether recently enacted state laws that prohibit mortgage brokers from arranging loans that do not meet certain underwriting standards could be applied to brokers when they are arranging loans for federally regulated lenders.
HUD/VA/GSE Developments
Moratorium on Risk-Based Premiums for FHA-Insured Loans
In July 2008, HUD shifted its mortgage insurance premium structure to a risk-based structure based on a combination of borrower credit scores and loan-to-value ratios. In response to the FHA Modernization provisions of the Housing and Economic Recovery Act of 2008, however, HUD is now required to implement a one-year moratorium on its new risk-based premium structure. HUD recently released Mortgagee Letter 2008-22, which, effective October 1, 2008, rescinds the Department’s risk-based premium guidance and sets forth new requirements for up-front and annual mortgage insurance premiums for FHA-insured loans. The Mortgagee Letter also provides guidance with regard to the use of borrower credit scores to assess a borrower’s credit risk. For instance, FHA has determined that borrowers with decision credit scores below 500 and with loan-to-value ratios at or above 90 percent are not eligible for FHA-insured mortgage financing. Such a provision appears to be HUD’s attempt to salvage some parts of its now-rescinded risk-based premium insurance program. (LINK)
Borrower Downpayment Requirement Increases for FHA-Insured Loans
Until the recent enactment of the Housing and Economic Recovery Act of 2008, FHA guidelines required borrowers to make a 3% cash investment in the transaction, which could include a downpayment and borrower-paid closing costs. This requirement will change effective January 1, 2009, and HUD recently released Mortgagee Letter 2008-23 to provide guidance to mortgage lenders regarding these changes. Notably, for all new FHA case number assignments on or after January 1, 2009, the Mortgagee Letter advises that a borrower must make a 3.5% cash downpayment, and closing costs may not be used to meet the minimum amount. Moreover, given the 3.5% downpayment requirement, the appropriate loan-to-value ratio for all purchase-money mortgages will be 96.5%. Thus, to determine the maximum mortgage amount for which FHA borrowers are eligible, lenders will be required to apply the 96.5% figure to the lesser of either (i) the appraiser’s estimate of value; or (ii) the contract sales price for the property (minus any required adjustments, such as seller concessions above 6% of the sales price). (LINK)
Broker Advisors No Longer Permitted in HECM Transactions
The Housing and Economic Recovery Act of 2008 also enacted provisions affecting Home Equity Conversion Mortgages (“HECM”), which are FHA-insured reverse mortgage loans. One such provision requires that all parties that participate in the origination of HECM loans must be approved by HUD.
While this language itself does not appear to be groundbreaking, its effect is sure to change the way many HECM loans are currently originated - namely, with the assistance of non-approved advisors. In response to the Housing and Economic Recovery Act of 2008’s HECM requirements, HUD recently issued Mortgagee Letter 2008-24, which effectively outlaws the use of non-FHA-approved advisors in connection with HECM transactions. It does so by rescinding Mortgagee Letter 2008-14, which HUD issued in May 2008. Beginning with case number assignments made on or after October 1, 2008, only FHA-approved mortgagees may participate and be compensated for the origination of HECM loans. As a result, the use and compensation of “advisors” in connection with the origination of HECM loans may no longer be permissible. (LINK)
Freddie Mac Underscores Requirements Related to Quality Control Reviews
On September 4, 2008, Freddie Mac released an Industry Letter to its approved sellers and servicers as a reminder of Freddie Mac’s requirements related to post-funding quality control underwriting reviews. Notably, the Industry Letter highlighted many of the timing requirements imposed on seller/servicers. For instance, if a loan is selected for a post-funding quality control review, the seller/servicer must submit the requested loan file to Freddie Mac within 15 days of Freddie Mac’s request. If Freddie Mac discovers any underwriting deficiencies with the loan, the seller/servicer has 30 days from the date of Freddie Mac’s request to take remedial action. Similarly, if Freddie Mac requires repurchase of a loan following a post-funding quality control review, the seller/servicer must appeal the action or else remit the repurchase funds within 30 days from the date of Freddie Mac’s letter requiring repurchase. Freddie Mac emphasizes in the Industry Letter that these requirements are not new ones. Rather, given the unprecedented times in the mortgage market, Freddie Mac expects to increase its quality control efforts. (LINK)
State Developments
Illinois Imposes Default and Foreclosure Reporting Requirements on Servicers
Many state regulators, such as those in New York and North Carolina, have begun imposing reporting requirements on mortgage servicers so that they can get a handle on the severity of loan delinquencies, defaults, and foreclosures, and perhaps an early warning before those borrowers get into trouble. With little prior notice, Illinois regulators joined those states, announcing new biannual reporting obligations on loan servicers. In addition to asking for statistical information about modifications, the reporting form asks servicers to provide narrative descriptions of such things as the servicers’ proactive loss mitigation steps, “including calls and mailings to borrowers" and "participation at community outreach events.” The first of these reports is due this week.
Massachusetts Applies Community Investment Regulations to Mortgage Lenders and Brokers
Community-type reinvestment provisions are common fare for depository institutions, but that has not been true for non-depository lenders, such as mortgage lenders and brokers. That has now changed in Massachusetts, where community investment regulations applicable to mortgage lenders and mortgage brokers became effective on September 5, 2008. The regulations implement a new provision of that state’s licensing law, which was passed as part of the state’s response to the foreclosure crisis.
The statute and implementing regulations subject Massachusetts mortgage lenders and brokers to standards that are very similar to those set forth in the federal Community Reinvestment Act of 1977 (“CRA”). Mortgage lenders and mortgage brokers will be assessed on their record of meeting the mortgage credit needs of borrowers in Massachusetts, including low- and moderate-income neighborhoods and individuals. The assessment will be based upon a lending test and a service test — but not an investment test — that are similar to those applicable to banks. A licensee’s community investment rating will affect the procedures for it to obtain approvals of any applications, including license renewals, establishment or renewal of any branch, and mergers and acquisitions.
The consequences of a poor record under the new regulations for a mortgage lender may be far greater than a poor CRA record for a bank. A poor record could possibly result in non-renewal of a license, which would force a mortgage lender to cease lending operations in Massachusetts. (LINK)
While the federal government continues to struggle with the foreclosure crisis, states are adopting a variety of approaches to slow down foreclosures in their communities. New Jersey is the latest to join the ranks of more than ten other jurisdictions that have enacted such laws during 2008, but the New Jersey law takes a novel approach by extending the introductory rate of an adjustable rate mortgage for 3 years.
Effective September 15, 2008, AB 2780, the Save New Jersey Homes Act of 2008 applies to certain borrowers with adjustable rate mortgages who have received a foreclosure notice with respect to their principal residence and whose introductory rate or rate reset terms meet defined criteria. To be eligible for this three-year rate relief and the statutory suspension of foreclosure proceedings, the borrower must, among other things, certify that he or she does not have sufficient income to pay the monthly payments after the rate resets, and agree to repay all deferred interest at the time the mortgage is paid off. The Save New Jersey Homes Act of 2008 requires creditors to send written notices containing prescribed language and carries significant penalties for willful violations of its terms. (LINK)
State Foreclosure Prevention Working Group Issues Data Report #3
The State Foreclosure Prevention Working Group, a multi-state group made up of state attorneys general and state banking regulators, recently issued its third report on the performance of subprime mortgage servicing, calling the evidence “profoundly disappointing.”
Over the past year, the Working Group has been collecting data from servicers on a monthly basis. Their latest report finds:
- that the majority of seriously delinquent borrowers are not on track for any loss mitigation,
- the use of short sales is increasing while loan modifications are on the decline,
- 20% of loan modifications made in the past year are currently delinquent, and
- foreclosure rates remain high.
According to the Working Group, “[s]ervicers appear to have reached the ‘low hanging fruit’ of subprime loans facing interest rate resets, while not developing effective approaches to address the bulk of subprime loans which are in default before interest rate resets.” This has led to property value declines and additional losses on mortgage loan foreclosures, according to the report. Given the number of ARM loans facing reset over the next two years, the Working Group predicts another wave of preventable foreclosures.
With the exact terms of a federal bailout plan uncertain at the time of this writing, this report may fuel a more aggressive implementation of a foreclosure mitigation program at the federal level should a bailout plan be enacted. A copy of the report is available here.
Posted on October 6, 2008 by K&L Gates
Perhaps not surprisingly, the FBI and DOJ have joined a host of other federal and state authorities and opened investigations stemming from the credit crisis. On September 29, 2008, both Freddie Mac and Fannie Mae separately announced that, in connection with a federal criminal investigation regarding accounting, disclosure and corporate governance matters, they had received federal grand jury subpoenas from the United States Attorney’s Office for the Southern District of New York. Both have pledged cooperation. Reportedly, the FBI is also looking into Lehman Brothers, AIG and 22 other institutions.
The opening of such investigations was predictable. Less predictable is whether DOJ will find evidence of criminal activity — particularly in an area as complex as mortgage financing.
The New Guidelines
Leaving aside the likely results of these probes, the investigations come at something of a turning point for DOJ. A little over a month ago, on August 28, DOJ revised its Principles of Federal Prosecution of Business Organizations (the “Principles”), which are part of the United States Attorneys’ Manual (“USAM”), the guidebook for all federal prosecutors. (See the DOJ’s press release; the relevant USAM provisions can be found here.)
In the revision (henceforth the “2008 Principles”), DOJ retreated from its widely-criticized position that federal prosecutors could demand that corporations — and by extension, individuals — waive the attorney-client privilege and work-product protection as a necessary precondition in earning credit for cooperating with DOJ, a point of major dispute with the legal community at large. This policy change, likely forced by Congress’ threats to mandate just such a reversal, is significant. Most critically, in cases handled by DOJ, the new policy largely re-establishes the right of a corporation to confer with its attorneys without fear that the attorney-client privilege which protects those communications from disclosure will be sacrificed. That said, it remains to be seen how the changed guidance will work in practice as these new Principles are tested in the crucible of high-profile investigations growing out of the current crisis.
Federal prosecutors have broad discretion in deciding whether to charge a corporate entity with a crime. Companies may be held criminally liable for the conduct (or omissions) of their agents committed within the scope of their duties and intended, at least in part, to benefit the corporation. Thus, as a matter of law, the crimes of any employee in the organization, regardless of whether he or she occupies a high or low position on the organization chart, may be attributable to the company and the company can be charged criminally for them. Whether DOJ seeks to bring a federal criminal case against the corporation in circumstances like these is a matter of discretion, which in turn depends upon the corporation’s cooperation as measured under the Principles.
The 2008 Principles contain several significant changes to DOJ policy guidance on charging companies with criminal conduct.
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Prohibition on requesting privilege waivers. The 2008 Principles no longer require waiver of the attorney-client privilege or work-product protection to qualify for cooperation credit. Indeed, the 2008 Principles prohibit prosecutors from requesting attorney-client and work-product waivers. But they do permit those prosecutors to request that corporations produce facts, however they are gathered; “credit for cooperation will not depend on the corporation’s waiver of attorney-client privilege or work-product protection, but rather on the disclosure of relevant facts.” In other words, the 2008 Principles recognize that companies may voluntarily choose to waive the work-product and attorney-client privilege protections in providing facts, but they are not required to do so, and prosecutors cannot expressly seek an attorney-client waiver in making such a request.
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Indemnification of employees. The 2008 Principles provide that prosecutors generally should not consider whether corporations indemnify their employees for legal fees incurred in defending themselves in criminal investigations or prosecutions, nor should prosecutors ask corporations to refrain from advancing attorney’s fees or providing counsel to employees under investigation or indictment. Such practices should only be questioned by prosecutors if they are part of an effort to obstruct justice – such as “if fees were advanced on the condition that an employee adhere to a [false] version of the facts.”
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Joint defense agreements. The 2008 Principles state that a corporation’s involvement in a joint defense agreement — an agreement by which potential defendants share information regarding the defense without losing the attorney-client privilege protecting the shared information from disclosure — “does not render a corporation ineligible to receive cooperation credit, and prosecutors may not request that a corporation refrain from entering into such agreement.” The 2008 Principles add, however, that the government may properly request the corporation not share “sensitive information about the investigation that the government provided to the corporation” with others to get cooperation credit.
It is unclear whether the sometimes fine line between a government request for facts and one that seeks a waiver of the privilege will be adhered to in practice by prosecutors. In practical terms, companies and their lawyers involved in investigations into the credit crisis must be careful to preserve the attorney-client privilege and work-product protections, as the 2008 Principles put the burden of preserving these confidences on them. Doing so may be critical – waiver of the privilege in producing information to the government in a criminal investigation is almost always considered by courts to be a waiver as to all other parties, including parties in civil actions. Corporations facing criminal exposure are thus well advised to consult as early as possible with qualified criminal counsel to assist them in navigating these still-dangerous waters.
Posted on October 6, 2008 by K&L Gates
By: David N. Jonson
In mid-September, the North American Securities Administrators Association (“NASAA”) held its 91st Annual Conference in Las Vegas. Securities regulators, industry experts and political commentators appeared on several panels before almost 400 attendees and discussed topics ranging from risk/reward analysis to how the next administration will regulate the financial services industry to the future of global financial services.
The general consensus of these panelists was that the financial services industry and federal regulators had failed on a number of levels, and for a number of reasons, to understand and manage the increasing amounts of risk being taken by market participants who had been driven to excesses by unduly focusing on short-term profits and compensation rather than long-term value creation. Panelists repeatedly blamed federal financial and securities regulators for failing to exercise their authority over the financial services industry.
State securities regulators, however, largely escaped the panelists’ criticism because they had quickly coordinated their enforcement efforts and reached settlements in matters of national import, such as Auction Rate Securities, which traditionally would have been spearheaded by federal regulators such as the SEC. By demonstrating their value and proactivity at the very same time that federal regulators have been considered to be lacking, the states have all but ensured themselves a place at the table as a new financial regulatory scheme is crafted in the coming months. Flush with their recent successes, state securities regulators can be expected to be more assertive in 2009 and beyond in matters of national importance, such as annuities, brokered CDs, reverse mortgage schemes and virtually any investment promotion affecting America’s increasing population of senior citizens. As NASAA’s president Fred Joseph said in his inaugural speech, invoking The Blues Brothers, “We can’t be stopped. We’re on a mission.”
Posted on October 6, 2008 by K&L Gates
By: Irene C. Freidel
On September 24, the Seventh Circuit Court of Appeals in Andrews v. Chevy Chase Ban, 2008 WL 4330761 (7th Cir. Sept. 24, 2008), joined two other federal appeals courts and the California Court of Appeals in holding that a class action may not be maintained for rescission of mortgage loans under Section 1635 of the Truth in Lending Act (“TILA”), 15 U.S.C. §§ 1601, et seq. (See also McKenna v. First Horizon Home Loan Corp., 475 F.3d 418 (1st Cir. 2007); James v. Home Constr. Co. of Mobile, Inc., 627 F.2d 727 (5th Cir. 1980); LaLiberte v. Pacific Mercantile Bank, 53 Cal. Rptr. 3d 745 (Cal. Ct. App. 2007), cert. denied, 128 S. Ct. 393 (2007)). The Andrews decision is likely to have an immediate impact on pending cases seeking class-wide TILA rescission against creditors and loan assignees both within the Seventh Circuit and elsewhere, as plaintiffs’ class action attorneys have placed this issue front and center in the debate over what remedies are properly available to borrowers who obtained high-risk mortgage loans. Unquestionably, class-wide rescission of tens of thousands of mortgage loans would result in substantial liability to any entity against which a judgment is entered.
Over the last year, more than 40 class actions have been filed on behalf of thousands of borrowers in California federal courts seeking damages and class-wide rescission of pay-option adjustable rate mortgage loans. These loans are at the core of the current mortgage crisis. None of the courts handling these cases has yet to decide whether the classes should be certified or whether class rescission under TILA is appropriate.
In support of its decision against a class-wide rescission remedy, the Andrews court noted, among other reasons, that rescission requires a complete “unwinding [of] the transaction in its entirety and thus requires returning the borrowers to the position they occupied prior to the loan agreement.” When a consumer exercises the right to rescind, the lender’s security interest in the real property becomes void and the lender is obligated to take steps within 20 days after receipt of notice to reflect termination of the security interest. The consumer will not be liable for, among other charges, finance charges; thus, the creditor must return any money or property given to anyone in connection with the transaction. When the creditor has complied with these obligations, the consumer must then repay the loan proceeds to the creditor. Thus, the court concluded that this “purely personal” and “highly individualized remedy” involves a “transactional unwinding” process that makes it “an extremely poor fit for the class-action mechanism.”
With the Andrews decision, the Seventh Circuit is now the third federal appeals court to reject class-wide rescission as a remedy available under TILA, making it more likely that courts in other jurisdictions, including California, will adopt this ruling. For a more detailed discussion of the Andrews case, see here.
Posted on October 6, 2008 by K&L Gates
By: Michael J. King
In testimony before the House Financial Services Committee (“Committee”) on September 18, 2008, Linda Thomsen, Director of the SEC’s Enforcement Division, and Susan Merrill, FINRA Executive Vice-President and Chief of Enforcement, said that they were investigating individuals in connection with the sale of auction rate securities (“ARS”) and that they would bring enforcement actions against individuals if their ongoing investigations revealed misconduct. Their prepared remarks may be found here and here. Their complete testimony may be viewed here. Committee Chairman Barney Frank convened the hearing in order to examine the continuing crisis in the market for ARS and to explore potential resolutions.
In August, the SEC announced preliminary settlements in principle with four broker-dealers (Citigroup, UBS, Wachovia, and Merrill Lynch) that will make available more than $40 billion in liquidity to purchasers of ARS. Specific charges were not announced, but they will relate to alleged misrepresentations concerning safety and liquidity in the sale of ARS. During the September 18 testimony, Ms. Merrill announced that FINRA had also entered into agreements in principle with five broker-dealers to settle charges related to the sale of ARS, pursuant to which the firms would offer to repurchase up to $1.8 billion of ARS from individual investors and some institutions. FINRA charged the firms with supervisory violations and with using advertising and marketing materials that did not provide a sound basis for evaluating the purchase of ARS. FINRA’s Press Release describing the agreements in principle in more detail can be read here. Both the SEC and FINRA are continuing to investigate conduct at the settling firms and at other firms as well. According to FINRA’s Press Release, 50 additional investigations have been opened and more are expected.
None of the SEC or FINRA actions announced to date have named any individuals. However, in response to Committee member questions about individual misconduct and accountability, Ms. Merrill stated that FINRA was investigating individual brokers and implied that they could be suspended or barred from the industry if FINRA found that they engaged in misrepresentations or suitability violations in connection with the sale of ARS. In response to separate questions, Ms. Thomsen also said that the SEC’s investigations were ongoing and to the extent that individuals were involved in “bad behavior,” the SEC will pursue actions against them to the extent that they can “establish cases.”
Given the testimony of Ms. Thomsen and Ms. Merrill, and FINRA’s announcement that more investigations will be opened, even firms that are not currently the subject of regulatory inquiries should closely examine the conduct of individuals if the firm has sold a significant amount of ARS. Although, so far, FINRA has only charged violations of advertising and supervision rules, sales practice violations can provide a separate basis for liability for the firm, and, of course, the individual salesperson. Since the potential sanctions identified by Ms. Merrill are severe, firms will certainly want to know if they have salespersons who could face such sanctions.
Any firm that discovers clear misconduct in connection with ARS sales should consider disciplining the employee and making the customer whole, regardless of whether they are currently subject to regulatory scrutiny. If there is a regulatory investigation, individuals may need separate counsel and the firm should review its indemnification and professional liability policies. Firms should also review their compliance and supervisory procedures with regard to sales practices and make enhancements when appropriate. Firms that have closely examined their employees’ activities, taken corrective and remedial action when necessary, and upgraded their compliance and supervisory procedures will be in a better position to deal with regulators whether they are currently involved in a regulatory investigation or become subject to one.
Posted on October 6, 2008 by K&L Gates
By: Philip J. Morgan, Robert V. Hadley
A hallmark of enforcement by the U.K. Financial Services Authority (the “FSA”) in 2008 has been the effort to establish that abusive behavior is likely to trigger severe personal consequences - so-called “credible deterrence.” The FSA is now spreading the message that it is “getting tough” and intends to increase its focus on deterrence through enforcement action.
The FSA has been saying for some time that it intends to boost credible deterrence and engage senior management in particular in relation to its strategic priorities of combating market abuse and insider dealing by three strategies: higher financial penalties; greater focus on enforcement actions against individuals rather than or as well as firms; and the prosecution of criminal cases. Yet many have wondered when the rhetoric would be matched by action. In all of 2007 the FSA imposed just one fine for abuse-related activity. By the start of 2008 the FSA had brought one successful criminal prosecution since its establishment under the current regulatory regime on 1 December 2001. It had prosecuted nobody for the criminal offence of insider dealing.
Now, things appear to be starting to change. The FSA has said that in order to achieve its aim of credible deterrence it must prosecute “a steady stream” of criminal cases. Thus, in January of this year the FSA launched its first criminal prosecution for insider dealing against two individuals, one of whom was an in-house counsel. In July it commenced two more prosecutions, one against a former Cazenove partner. There are said to be several others in the pipeline.
Also, on July 29, 2008, an extensive dawn raid operation was mounted on various addresses by the FSA under search warrants. Eight individuals were arrested. The FSA said that this was in connection with “a major ongoing investigation into insider dealing rings.” The FSA does not comment on ongoing investigations, but this was a further clear demonstration of intent.
Individuals, and especially senior management and others in the regulated sector, can be in no doubt that there is at least some risk of criminal prosecution for insider dealing and other market manipulation offences. The risk is not merely of financial penalty imposed on their firm, or even on them personally. Certainly no one can any longer say that the FSA has never prosecuted anyone for such activities. The FSA’s aim is that any person with access to inside information or other opportunity to abuse the market should believe that these criminal cases are the first of its “steady stream,” and to think clearly that that is not where they wish to swim.
The FSA also will point to other recent actions as evidence of its new, more aggressive posture toward enforcement.
In the past two months, the FSA fined Credit Suisse £5.6 million for the mismarking of certain positions resulting in an overstatement in published accounts corrected some eight days later, and fined a GE Money mortgage brokerage operation £1.1 million for defective systems and controls leading to its not accounting correctly for customer funds, so that, for example, mortgages were overpaid on redemption and clients’ money was not applied to their mortgage accounts promptly or accurately (both fines imposed after the FSA acknowledged the full cooperation of the firms and after applying the 30 percent reduction for settling at an early stage of the enforcement process). These cases are examples of the higher financial penalties that the FSA intends to seek.
The FSA fined Land of Leather Limited in May in relation to inadequate systems and controls to prevent the sale of Payment Protection Insurance which was unsuitable for customers’ needs, but will stress that it also fined the company’s Chief Executive £14,000 (after a 30 percent early settlement reduction) in respect of the same matter. This shows the FSA’s willingness to pursue senior management on the basis of senior management’s responsibility for a firm’s regulatory compliance.
Similarly the FSA extracted an undertaking from Mr. Steven Harrison, an investment manager at a hedge fund, effectively that he stay out of the financial services industry for 12 months (in addition to a financial penalty of £52,500 - after the 30 percent early settlement reduction). The allegation was market abuse in the sense of instructing colleagues to purchase certain bonds while in possession of inside information. The final notice acknowledges that Mr. Harrison’s conduct was not deliberate in the sense that he did not consider at the time that he had inside information, but the FSA’s position was that he should have recognized that fact. The FSA thus intends to promote deterrence not only by fining individuals, but also by affecting their continued ability to earn their livelihood in the financial services sector.
Posted on October 6, 2008 by K&L Gates
By: Philip J. Morgan
In general, a person seeking to acquire a stake of 10% or more in an EU credit institution, securities firm or insurance firm has to obtain prior approval from the relevant local regulator. However, the current EU directives mandating the relevant approvals process permit Member States to impose additional requirements over those in the relevant directives. This has left scope for national regulators to adopt protectionist practices such as making unreasonable requests for information during the approvals process, refusing applications or imposing conditions on grounds unrelated to the purpose of the underlying directives.
This problem, which has impeded cross border acquisitions across Europe contrary to the aims of the EU Financial Services Action Plan, is now being addressed by the Acquisitions Directive (2007/44/EC) (the “Directive”) which is required to be brought into law in EU Member States by 21 March 2009. The Directive's aim is to facilitate and encourage cross border acquisitions by increasing certainty, clarity and transparency, and Member States are not permitted to impose rules additional to those in the Directive.
The Directive seeks to harmonise the supervisory approvals process by setting out the entire procedure to be applied by regulatory authorities including fixing deadlines, limiting the ability of regulators to "stop the clock" by asking questions, and clearly laying down uniform prudential criteria for the assessment (which are the only criteria that may be applied).
In the UK, the adoption of the new rules is not currently expected to make any very material changes to the current "change in control" regime, although there will be a slight shortening of about a week of the period, currently 3 months, within which the Financial Services Authority must make its decision.
Harmonisation of the rules across the EU should, however, mean that anyone, including those from outside the EU, looking to acquire European financial firms may find that task somewhat more straightforward. This might be expected to trigger, or at least facilitate, a new wave of consolidation in the European banking, insurance and securities industries.
Posted on October 6, 2008 by K&L Gates
By: Edward G. Eisert
On September 15, 2008, the Second Circuit Court of Appeals issued a Summary Order in the case brought by CSX Corporation (“CSX”) against The Children’s Investment Fund Management (UK) LLP and 3G Fund L.P. that affirmed the decision of the Southern District of New York not to enjoin the voting of the CSX shares acquired by the defendants in their proxy fight with CSX management. Stating that an opinion would follow, the Second Circuit did not rule on the other issues of the case that are of great significance to the financial community — particularly the treatment of total return swaps (“TRSs”) under the Securities Exchange Act of 1934 (the “Exchange Act”).
The June 11 decision of the District Court found that through the undisclosed use of TRSs, the defendants had violated Section 13(d) of the Exchange Act and the rules thereunder and enjoined further violations thereof, dismissed all counterclaims, but held that it was “foreclosed” under controlling Second Circuit precedent from enjoining defendants from voting the shares they had acquired from the date of the violation to the trial date.
Thus, the decision of the District Court has called into question a basic expectation of the equity derivatives market: that the long party to a TRS does not acquire beneficial ownership of the referenced securities under the TRS for purposes of Section 13(d), absent a supplemental arrangement outside of the TRS that provides a contractual right to vote or dispose of such securities.
The opinion of the Second Circuit is being anxiously awaited by the financial community, particularly in light of the current market turmoil. For a detailed discussion of the decision of the District Court see the K&L Gates June 2008 Alert.
