Dodd-Frank

SEC Issues Controversial Rule Regulating Asset-Backed Securities

By by Andrew Sioson, J.D. Class of 2013 | Posted on

The SEC will soon put the finishing touches on a rule stemming from one of the most infamous cases of fraud from the 2007-08 financial crisis. The new rule prohibits certain material conflicts of interest between those who create or distribute asset-backed securities (ABS), including synthetic ABS, and the investors in the ABS. This proposal takes direct aim at a transaction that, within the securities industry, has become a symbol of greed and profiteering: Goldman Sachs’s Abacus transaction.

Abacus 2007-AC1 (“Abacus 2007” or “Abacus”) was an investment vehicle designed to fail. It was created in February 2007 at the request of John Paulson, the hedge fund manager who made billions of dollars during the recession by shorting subprime mortgage-backed securities (MBS). Paulson selected the pieces of toxic subprime MBS that he wanted to short which were then packaged together and sold by Goldman to its clients, including German bank IKB and Dutch bank ABN Amro. The buyers were not aware that Paulson selected Abacus’s underlying portfolio; in fact, these banks were led to believe that an independent third party selected the mortgages. The Abacus 2007 transaction resulted in massive losses for IKB and ABN Amro, while Paulsen profited from the investment vehicle’s demise to the tune of over $1 billion.

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Banking Supervision: Capital Conservatism

By By Vibhooti Malhotra, L.L.M Class of 2012 | Posted on

The broad supervisory standards and guidelines issued by the Basel Committee on Banking Supervision (‘the Committee’) have greatly influenced the manner in which Banks are organized in various jurisdictions. The Committee claims that the main culprit behind the current financial crisis is excessive leverage assumed by banks both on and off the balance sheet. The latest in the series of proposed changes propounded by the Committee is Basel III, which seeks to restructure banks like shock absorbers rather than transmitters of financial risk.

The Federal Reserve Bank (‘Federal Reserve’) has responded to Basel III by asking bank holding companies (‘BHCs’) to submit comprehensive capital plans over the next 24 months. It is noteworthy that BHCs are required to notify the Federal Reserve of any change in their capital structure under Section 224.5(b) of Regulation Y issued under section 5(b) of the Bank Holding Company Act of 1956. Basel III, which has been designed conservatively, creates a framework whereby banking companies are to maintain higher common equity ratios, institute tougher stress tests for liquidity, and enhance market discipline and disclosure, among other things. Furthermore, trading positions will be subject to more stringent review, as the Federal Reserve believes that such changes are in the spirit of financial reform initiated by the Dodd-Frank Act.

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Volcker Rule Update #2: Comment Period Extended; Analysis of the Hedging Exemption

By Peter Benesch, J.D. Class of 2013 | Posted on

The deadline for submitting comments regarding the proposed regulations implementing the Volcker Rule has been extended from January 13 to February 13. As we noted in our previous update on the Volcker Rule, the timeline was already very tight if regulators intended to meet the implementation deadline of July 2012, and this postponement only makes that timeline even tighter and less feasible.

Putting this logistical problem to a side, one major provision in the proposal we have yet to discuss in-depth is the exemption provided in the Volcker Rule for risk-mitigating hedging transactions. The current proposal would allow banks to maintain, purchase, or sell hedging positions with commercial deposits provided that these positions arise from and are related to specific risks involved in the bank’s other legitimate positions, contracts, or holdings. These other risks include market risk, counterparty/credit risk, currency/foreign exchange risk, and interest rate risk (among others). Additionally, the hedged positions taken by the bank must be “reasonably correlated” (or, to be more precise, reasonably negatively correlated) with the risks purportedly being mitigated.

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Update: 298 Page Volcker Rule Proposal Leaves Much To Be Desired (And Decided); Issue #1: Market Making

By Peter Benesch, J.D. Class of 2013 | Posted on

On October 12th the Federal Reserve, FDIC, Office of the Comptroller of the Currency, and SEC submitted the long-awaited proposal for implementation of Section 619 of the Dodd-Frank Act, widely referred to as the “Volcker Rule.” Legislators included this section in the Dodd-Frank Act in order to divide commercial banking and depository functions, which are federally insured, from banks’ investment activities (commonly referred to as “proprietary trading”). Given the fact that many large commercial banks, such as Bank of America and JP Morgan Chase, derive a significant portion of their revenue (8% and 9%, respectively) from their trading desk, the details of the rule could have enormous implications for the future financial strength and stability of depository institutions.

The proposal has several large exceptions to its prohibition on proprietary trading in order to allow banks to continue to provide important financial services to their customers. One of the largest exceptions is for market making. Market making can involve a number of activities, but at its core it consists of financial institutions accepting client requests to purchase (or sell) any given security without that financial institution immediately going out into the market and finding a seller (or buyer). In order to facilitate this process, financial institutions involved in market making may maintain a stock of various securities that they buy and sell to clients as needed to meet client demand. Under the new proposal, banks would be allowed to purchase and sell securities under the premise of market making so long as: a.) the bank “holds itself out” as being willing to buy and sell those securities to and/or from clients, b.) the purchases or sales do not exceed “reasonably expected near term demands” of clients, c.) the activities are primarily intended to generate income from fees, commissions, and bid-ask spreads (as opposed to appreciation or depreciation in the securities themselves), and d.) the compensation arrangements of employees engaged in market making is not designed to reward large returns that may result from the appreciation or depreciation of the securities themselves.

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Flying Under the Radar, New Municipal Advisor Rules May Alter the Municipal Securities Landscape

By By Andrew Sioson, J.D. Class of 2013 | Posted on

Dodd-Frank mandates fundamental changes in the oversight of the municipal securities market. Section 975 amends section 15B of the Securities Exchange Act of 1934 by requiring that municipal advisors register with the SEC in a similar manner as traditional investment advisors. The proposal has been met with controversy, as critics like Clifford Kirsch, a partner at Sutherland Asbill & Brennan, state that the proposal “goes much further than what was anticipated in Dodd-Frank.”

Municipal securities, such as municipal bonds, are issued by local governments and cities to fund their operations, as well as large projects. Historically, the municipal securities market has been less regulated than other capital markets, but Section 975 of Dodd-Frank significantly increases regulatory oversight of issuers and industry professionals. In December 2010, the SEC proposed rules specifying potential registration requirements and criteria governing mandatory registration for municipal securities advisors. Until Dodd-Frank, the activities of these advisors were largely unregulated. However, regulators came to the conclusion that change was needed when several municipalities were rocked by unscrupulous advice regarding the issuing of securities. For instance, Jefferson County, Alabama is in the midst of rare municipal bankruptcy proceedings after it relied on advice from JPMorgan and borrowed 3.2 billion dollars in floating instead of fixed rate debt. With the proposed municipal advisor rule, the SEC intends to protect municipalities from excessive risks and fees.

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California’s Response to Dodd Frank and the Repeal of the “Private Advisers” Exemption

By Charles Rogerson, J.D. Class of 2013 | Posted on

By Charles Rogerson

The Commissioner of the California Department of Corporations is considering amending Rule 260.204.9 of Title 10 of the California Code of Regulations in response to the repeal of the “private advisers” exemption mandated by the Dodd-Frank Act. The former exemption, found in the Investment Advisers Act of 1940 (“Advisers Act”), had allowed specified investment advisers with fewer than fifteen clients in any twelve-month period to forgo SEC registration. Notably, the exemption counted each fund as a single client, not each individual investor. This exemption had a corollary in the California Code under 260.204.9. As amended by Dodd-Frank, the Advisers Act requires investment advisers with assets in excess of a specified statutory amount ($25 to $100 million) to register with the SEC.

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Will Concepcion Allow Arbitration Agreements to Squash Consumer Class Actions?

By James Nguyen, J.D. Class of 2013 | Posted on

Not entirely—at least that’s the conclusion according to this article in the most recent ABA Infrastructure issue.The key holding of the Supreme Court decision in AT&T Mobility LLC v. Concepcion–that the Federal Arbitration Act (FAA) preempts any state rule invalidating class-action waivers (such as the Discover Bank v. Super. Ct. rule in California prohibiting non-class arbitration clauses)–significantly bolsters the already superior bargaining power of defendants in class-action suits and undermines the ability ofconsumers to even undertake these suits. (There is already some evidence that banks have increased adoption of arbitration clauses as a result of the decision)

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The Effects of Upcoming SEC Regulations Governing Accredited Investor Status

By Peter Benesch, J.D. Class of 2013 | Posted on

In March the SEC finished receiving comments on an alteration mandated by the Dodd-Frank Act that changes the calculation which determines whether an individual can be considered an “accredited investor.” The alteration, which already went into effect upon passage of the Dodd-Frank Act, excludes the net equity an investor may have in his/her home from the calculation of his/her net worth. This change is significant because there are a large number of relatively small financial institutions that are only allowed to engage accredited investors as clients, given those institutions do not comply with the plethora of filing/reporting requirements generally required for public offerings.

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Johnson, Sylvester, Funke, oh my!: The ARB Paves the Way for Greater SOX Whistleblower Protection

By Mike Perez, J.D. Candidate Class of 2012 | Posted on

Earlier this year, The Network reported on some changes made to the Sarbanes-Oxley (SOX) whistleblower provisions by the enactment of the Dodd-Frank bill. In recent months, the Administrative Review Board (ARB) – the appeals board for decision issued by Administrative Law Judges in the Department of Labor – has made monumental transformations to existing case law regarding whistleblower retaliation claims. The alterations the ARB has made are a clear departure from previous SOX whistleblower case law and revitalized whistleblowing as a public service deserving of protection.

Under 18 U.S.C. § 1514A, it is illegal for any public company subject to SOX to discharge employees, contractors, subcontractors or agents for informing certain entities about certain enumerated SOX violations. If an employee suspects that retaliatory acts were taken against them for their role in reporting a SOX violation, the employee must file a complaint with the Occupational Safety and Health Administration (OSHA) within 180 days of the retaliatory act – increased from 90 days by Section 922(b) of the Dodd-Frank Act. After OSHA conducts an investigation, it issues an initial decision. If either party disputes OSHA’s decision, that party may appeal to the Department of Labor Office of Administrative Law Judges. There, the purported whistleblower must establish a prima facie case for SOX protection. In order to establish a prima facie case, the claimant must prove (1) he or she engaged in SOX protected activity, (2) the respondent took unfavorable employment actions against complainant, and (3) the protected activity was a contributing factor to the adverse action.

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Dodd-Frank One Year Later: A Lot of Unfinished Business

By James Nguyen, J.D. Class of 2013 | Posted on

The one-year anniversary of the Dodd-Frank Act (DFA) marks an important moment to review and reflect on the transformative changes that have taken place since enactment of the sweeping reforms.  Yet, much of the work to implement those reforms is still underway.A slew of reports and studies were released to recognize the significant milestone, and of which there are a few worth reviewing:

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