Financial Regulation

The Week in Review: FB, BNY Mellon, and Cybersecurity

By Christopher Hammond, J.D. Candidate 2015 | Posted on

Facebook (FB) has cleared an important legal hurdle, as a S.D.N.Y. district court dismissed a lawsuit regarding its fumbled IPO last May.  The plaintiffs had argued that CEO Mark Zuckerberg and other directors should be liable for selectively disclosing negative measures of the company’s performance.  Judge Sweet disagreed.  Unsurprisingly, a Facebook representative said they were “pleased with the court’s ruling.”  For more, see CNBC.

The IRS won a major case in U.S. Tax Court earlier this week, and the ruling could cost the Bank of New York Mellon more than $800 million.  The dispute arose from Structured Trust Advantaged Repackaged Securities (STARS) – essentially manufactured tax shelters marketed by the bank.  In ruling against BNY Mellon, the Court held the STARS program was a “subterfuge for generating, monetizing and transferring the value of foreign tax credits.”  For more, see the Wall Street Journal.

In a follow-up to a previous Network post, President Obama has signed an executive order on cybersecurity.  However, the President’s order does not reach tough new regulations on private companies, falling short of last year’s proposed legislation, and does not allow for broad information sharing with government intelligence agencies as proposed by CISPA.  Congressional reaction to the executive order is yet to be determined—some commentators view the move as taking pressure off Congress to act on cybersecurity this term, but even President Obama, in his State of the Union address last night, addressed the need for a comprehensive law.  For more, see CNET and BBC.

The Week in Review: Major Suits and Proposed Legislation

By Christopher Hammond, J.D. Candidate 2015 | Posted on

The director of the U.S. Consumer Financial Protection Bureau may be facing a challenge the constitutionality of his “recess appointment,” following a January 25 ruling by the D.C. Circuit Court of Appeals.  In that case, the court held three of President Obama’s appointments to the NLRB were unconstitutional.  The party challenging director Richard Cordray’s status would likely argue that the opinion applies to him as well, as he was appointed via the same process.  For more, see Bloomberg.

The Justice Department has sued Anheuser-Busch InBev in Washington D.C. district court, attempting to block the company’s proposed $20.1 billion merger with Modelo.  The head of the DOJ’s antitrust division, William J. Baer, said the deal would reduce competition in the American beer industry, as InBev would control 46 percent of the country’s annual sales.  “Even small price increases could lead to significant harm,” Baer said.  For more, see the NYTimes.

The Commodity Futures Trading Commission is drafting rules for “swaps,” under the directive of the Dodd-Frank financial markets overhaul.  The stakes are high, as the complex instruments account for eight-ninths of the derivatives market—and Wall Street banks have been jockeying to frame the proposals as too burdensome for their respective industries.  For more, see Reuters.

Capitol Hill may again take up a system of voluntary cybersecurity standards.  According to a new Senate Commerce Committee report, there is strong support among Fortune 500 companies.  U.S. Senator Jay Rockefeller (D., W.Va.) has spearheaded the effort, and his data suggests differing perspectives from industry leaders and the U.S. Chamber of Commerce.  Sen. Rockefeller hopes to pass a bill this year.  For more, see the Wall Street Journal.

Morgan Stanley Settles for $5 Million with Regulator for its involvement in Facebook IPO

By Jared Mayberry, J.D. Candidate 2015 | Posted on

Morgan Stanley recently agreed to pay a $5 Million fine for its involvement in Facebook’s initial public offering.  The fine was agreed to without admitting or denying wrongdoing, and settled charges from a Massachusetts regulator that claimed the firm violated an earlier settlement agreement blocking investment bankers from influencing analysts.

In 2003, ten brokerage firms were penalized for their conduct during the dotcom bubble.  The 2003 settlement noted that the brokerage firms engaged in acts that were considered conflicts of interest between research analysts and investment bankers, and that the respective firms did not manage the conflicts appropriately.  The current  potential violation of the settlement arose when a senior Morgan Stanley investment banker informed an analyst that David Ebersman, Facebook’s CFO, believed revenue for the second quarter and full year would be lower than anticipated.

Fearing his conduct did not comply with the 2003 settlement, the banker convinced Ebersman to file an updated S-1 registration statement.  The senior investment banker testified that his solution was an attempt to “update analyst guidance without creating the appearance of not providing the underlying trend information to all investors.”  Ebersman wrote to the board that the updated S-1 would “help us to continue to deliver accurate messages at the road show meetings (without someone claiming we are providing any selective disclosure to big accounts only).”

Immediately after the filing of the S-1, Facebook’s Treasurer made 15-minute update calls to about twenty syndicated research analysts.  The senior investment banker rehearsed with the Treasurer for these calls, but was not present in the room when the calls were placed.  The $5 Million fine comes out of what Forbes approximates to be a $68 Million fee from Facebook for their work as an underwriter for its May offering.

According to the Chicago Tribune, the litigation concerning the Facebook’s IPO is not over.  A proposed class-action case has accused Facebook of misrepresentations of its financial condition leading up to the companies much-anticipated IPO.  Collectively, the group has claimed over $7 million in damages.

For previous Network coverage of Facebook’s IPO, see here and here.

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

This week, Manatt has a guide on “How to Handle Confidential Investigations of Bank Activities,” published in the ABA Banking Journal. The guide explains how banks should handle potentially suspicious transactions identified during a safety and soundness examination. The guide stresses that while not every suspicious transaction warrants a full outside investigation, those involving “significant employee or customer negligence or misconduct, or violations of law or regulations” likely require such an investigation. The guide explains the requirements for planning, conducting, and ensuring regulatory compliance throughout the investigation.

Last week, Gibson Dunn published its “2012 Year-End Securities Enforcement Update,” including some interesting findings. Keeping pace with last year, the SEC filed 734 enforcement actions extracting more than $3 billion in penalties and disgorgement. The update notes, however, “the SEC confronted significant challenges in litigating previously filed enforcement actions against individuals in cases related to the financial crisis.”  These challenges aside, the SEC significantly increased actions against investment advisors and broker-dealers, bringing 147 and 134 cases against each, respectively. The update breaks down the enforcement actions, explaining in detail the types of entities and conduct likely to raise the ire of the SEC.

Among other tax changes, the American Taxpayer Relief Act of 2012 extends the 100 percent capital gain exclusion for “qualified small business stock.” This exclusion originally was implemented as part of the Internal Revenue Code of 1986, but only excluded from capital gains tax 50 percent (in some cases 75 percent) of gains from the sale of qualified small business stock. The Small Business Jobs Act of 2010 increased the exemption to 100 percent and increased the time frame in which the deduction applied. The recent Taxpayer Relief Act extended the exemption period to January 1, 2014. In a recent Client Alert, Latham & Watkins explains the requirements of “qualified small business stock” and the benefits and limitations of the exclusion. The Client Alert is available for download here.

 

The Week in Review: New Mortgage Rules and Citigroup’s Q4 Hit by Settlement

By Christopher Hammond, J.D. Candidate 2015 | Posted on

In an ongoing effort to protect homeowners facing foreclosure, the Consumer Financial Protection Bureau has issued new rules for mortgage servicers.  The rules, which won’t take effect until January 2014, include provisions requiring banks to consider and respond to loan modification applications submitted at least 37 days before a schedule foreclosure.  Similarly, servicers must inform borrows of alternatives to foreclosure and will not be able to begin foreclosure proceedings while homeowners are seeking a loan modification.  The rules also severely limit some of the lending practices (e.g. inflated up-front fees, interest-only payments, and high debt-to-income ratios) considered predatory by consumer groups. For more detail, see articles by WashPo and CNN.

Citigroup’s Q4 earnings report underperformed this morning – in large part due to its $1.29 billion in legal costs – and the company’s stock dropped 3.4% in early trading.  While most banks are still purging their balance sheets, there is worry that we may not have seen the end of these mortgage-crisis-era liabilities.  Citigroup’s CFO, John Gerspach, hinted on a Thursday conference call:  “I think that the entire industry is still looking at some additional settlements that are still yet to appear.”  For more, see NYTimes and Reuters.  [Bank of America’s Q4 was hit by settlements as well:  WSJ]

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

Late last year, the Federal Reserve issued guidance on its new framework for supervising large financial institutions.  The Federal Reserve’s primary objectives will be to increase the resiliency of financial institutions, and to reduce the impact of an institution’s failure on the broader economy.   Changes include a greater emphasis on recovery and orderly resolution planning as required by Dodd-Frank.  In a recent publication, Sullivan & Cromwell reviews the specifics of the recent changes and explains how their implementation may differ from the previous regulatory framework.

The expectation that courts will recognize and enforce the insolvency proceedings of foreign courts is essential to certainty and predictability of cross-border transactions.  This is especially important where the two nations’ bankruptcy laws materially differ.  Three recent decisions in the U.S. and U.K. call into question whether such an expectation is reasonable.  In one of the cases, the Fifth Circuit held unenforceable a $3.4 billion restructuring plan approved by a Mexican court as “manifestly contrary to the public policy of the United States.”  The Fifth Circuit took issue with the Mexican court’s decision that shareholders receive $500 million in value while higher-ranking creditors receive only 40 percent of their claims.  In a recent client alert, DLA Piper explains the implications of these decisions for certainty and predictability of cross-border transactions.

The U.S. District Court for the District of Columbia recently dismissed a lawsuit challenging recent amendments to CFTC Rule 4.5. With limited exceptions, the amendments require registration by investment companies that trade in futures, options, and commodities. The plaintiffs, the Investment Company Institute and the U.S. Chamber of Commerce, argued the amendments were arbitrary and capricious in violation of the Administrative Procedure Act and that the CFTC failed to perform adequate cost-benefit analysis. In rejecting these arguments, the court found that the link between unregulated derivatives and the financial crisis provided an adequate basis for the amendments. In a recent Client Alert, Ropes & Gray explains the court’s reasoning and the decision’s implications for registered investment companies.

Forthcoming in California Law Review: “From Independence to Politics in Financial Regulation” by Stavros Gadinis.

By Andrew B. Talai, J.D. Candidate 2014 | Posted on

Berkeley Law Professor Stavros Gadinis’s latest article, “From Independence to Politics in Financial Regulation,” is forthcoming in the California Law Review.  Professor Gadinis’s work focuses on the intersections between finance and government regulation.  This particular paper takes a global look at how governments reformed their “independent” financial regulatory agencies by making them more politically accountable after the 2007-08 financial crisis.

We at the Network found this article particularly interesting because it focuses on the fundamental—and often taken for granted—relationship between administrative law and business law.  In the United States, “agency independence has long been the hallmark of financial regulation.”  In fact, most governmental financial regulation occurs within the “headless fourth branch,” i.e., independent administrative agencies like the Federal Reserve (“the Fed”), Federal Deposit Insurance Corporation (“FDIC”), and Securities and Exchange Commission (“SEC”).

Historically, these governmental entities, corporations, boards, and commissions often have been insulated from direct democratic forces.  The theory is that, free from “generalist” whims and electoral politics, agency independence allows neutral “subject matter experts” to focus their particular skill and knowledge on the specialized problems they were commissioned to solve. Further, independent agencies bring the country long-term stability and uniformity.  Whereas elected politicians, so the theory goes, are often biased towards short-term goals to capture votes in the next electoral cycle.

When scholars speak of “independence” from political influence, they largely mean from the President’s removal power.  It has long been settled that Congress may “under certain circumstances, create independent agencies run by principal officers appointed by the President, whom the President may not remove at will but only for good cause.”  Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. __ (2010) (slip op. at 2).

However, too much independence can become a problem.  For example, in Free Enterprise Fund the Supreme Court held that a dual for-cause removal scheme Congress set up in the Sarbanes-Oxley Act was ultra vires of the Constitution’s separation of powers.  The Act placed members of the Public Company Accounting Oversight Board (“PCAOB”) under the SEC’s control, removable only for cause.  In turn, SEC commissioners were only removable by the President for-cause.  This novel structure, Chief Justice Roberts held, prevented the President from discharging his duty to “ensure that the laws are faithfully executed—as well as the public’s ability to pass judgment on his efforts.”

The anxiety that motivated Chief Justice Robert’s opinion in Free Enterprise Fund could partly be described as a fear of Congressional aggrandizement at the expense of the Chief Executive.  But it could also be described as a distrust of the growing independence of democratically unaccountable bureaucrats—the same distrust that Professor Gadinis comments on in his most recent article.

Professor Gadinis argues that a coalescence of unique atmospheric factors post the 2007-08 crisis led to a global shift from financial regulatory independence toward greater political accountability.  According to Professor Gadinis’s argument, those factors include (1) pervasive failures across multiple agencies charged with financial regulation, (2) failure of the market to self-correct, (3) fear of agency capture, (4) unprecedented voter interest, and (5) welcomed political assistance.

Professor Gadinis’s empirical data supports his premise in the United States, France, Germany, Australia, Belgium, Spain, Denmark, the United Kingdom and Ireland.  Only a few countries surveyed did not evince an increase in political accountability, and that was because they either already had a highly politically accountable system or were in the process of working out legislation.  In the United States, for example, one way this shift materialized was through the Dodd-Frank Act.  Significantly, the move toward political accountability did not take the traditional route, e.g., Appointment and Removal powers.  Instead, Congress sought to retain independent subject matter expertise, but at the same time make the Secretary of Treasury—who is directly accountable to the President—the final arbiter of agency decisions, rather than the agency head.

The upshot of all of this is that the administrative financial regulatory system in the United States, and likely worldwide has seen a paradigm shift.  While this shift can simply be seen as moving independent agencies back within the traditional executive agency structure, it is important to remain cognizant of the hazards of too much political influence.  After all, the benefits of the independence model are also the downsides of the political model.  Professor Gadinis discusses how, in the bailout context, considerations of electoral timing, adverse public opinion detached from economic reality, and opportunities for massive political contributions could improperly influence political actors.  Only time will tell where the line will be drawn in this canonical administrative law paradox.

Make sure to read the final version of the article in the California Law Review. The abstract is available after the jump. (more…)

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

Regulation FD mandates that issuers disclose material nonpublic information through “a Form 8-K, or by another method… reasonably designed to effect broad, non-exclusionary distribution of the information to the public.”  As the SEC’s recent investigation of Netflix shows, a disclosure by the CEO of such information on Facebook likely is insufficient.  In a similar incident earlier this year, Francesca’s Holding Corp. terminated its CFO after he tweeted, “Board meeting. Good numbers = Happy Board.”  This incident, however, did not result in an SEC investigation.  Despite these and other similar incidents, the SEC has provided no guidance on the applicability of Regulation FD to social networking.  In a recent Client Alert, Weil, Gotshal & Manges makes the case for additional guidance and explains how the SEC’s 2008 guidance on corporate website disclosures could be applied to social media.

UBS has agreed to pay a total of $1.5 Billion to regulators in the U.S., U.K., and Switzerland to resolve claims that it manipulated LIBOR.  The fine includes $1.2 Billion to the DOJ and CFTC.  The remainder will be paid to U.K. and Swiss regulators.  As part of the U.S. agreement, UBS must “take steps to ensure the integrity and reliability of UBS’s future benchmark interest rate submissions” and have its Japanese subsidiary plead guilty to one count of wire fraud.  The DOJ also filed a criminal complaint against two former UBS traders.  In a recent Client Alert, Goodwin Proctor has a full summary of the actions and links to the complaint and settlement agreements.

Fiscal year 2012 was significant for criminal cartel enforcement in the U.S.  The DOJ extracted $1.1 billion in fines, more than double that of 2011.  The average prison sentence for individuals also increased to 28 months from 17 months.  The banner year for the DOJ included investigations of 1) a five-year conspiracy to fix the prices of LCD panels, 2) an international conspiracy to fix LIBOR, and 3) a conspiracy among automotive part manufacturers, which has become the broadest antitrust investigation in U.S. history.  In the recently published U.S. Chapter of “Cartels: Enforcement, Appeals & Damages Actions,” Skadden succinctly explains U.S. antitrust laws regarding cartel enforcement and summarizes their application in 2012.

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

In a recent Client Alert, Wilson Sonsini reviews the 2012 proxy season, finding it “evolutionary, rather than revolutionary.” In the second year of the say-on-pay requirement, shareholder support for executive compensation averaged about 90 percent. Only three percent of say-on-pay proposals failed to garner the necessary majority of shareholder votes. Moreover, proxy access shareholder proposals—proposals by large shareholders to include their director nominees in the company’s proxy statement—enjoyed modest success in 2012. The Alert provides in-depth analysis of these results and recommendations for 2013.

A jury in Los Angeles recently found three former officers of the failed IndyMac Bank liable for $168 million in losses. The suit, brought by the FDIC, sought damages resulting from construction loan losses by the bank’s Homebuilder Division. In a recent Client Alert, Manatt analyzes the result and provides “lessons learned” from the jurors’ quick decision. Among other lessons, the firm suggests that officers are likely to be held to a higher standard than are directors when they actually approve the loans, especially in California where courts have consistently refused to extend the business judgment rule beyond directors.

The CFTC recently published a series of no-action letters, providing for: 1) a limited exemption for swap dealers from the prohibition against association with certain persons subject to statutory disqualification, 2) an exemption for swap dealers from the requirement to disclose counterparties when the entity has a reasonable belief that the disclosure would violate foreign laws, and 3) a limited exemption for certain futures commission merchants from the requirement that the chief compliance officer certify the annual report. In a recent Financial Alert, Goodwin Proctors has a full summary of these no-action relief letters, as well as an update on other regulatory news.

 

SEC Adopts Rules On Clearing House Standards

By Flore Poughon, LL.M. Candidate 2013 | Posted on

The Securities and Exchange Commission recently adopted a new, stricter rule governing risk management and operation standards for registered clearing activities.  This new Rule, 17 Ad-22, will become effective 60 days after its publication in the Federal Register.

The Rule requires registered clearing agencies that perform central counterparty services to establish, maintain and enforce written policies and procedures reasonably designed to limit their exposure. At minimum, they must measure their credit exposure at least once per day and maintain margin requirements to limit their credit exposure to participants, using risk-based models and parameters. The procedures must be reviewed monthly, and the models must be validated annually.

The Rule is an attempt “to ensure that clearing agencies will be able to fulfill their responsibilities in the multi-trillion dollar derivatives market and more traditional securities market.”  It is part of an effort to promote financial stability by improving accountability and transparency in the financial system. It was adopted in accordance with the Dodd-Frank Act, which gave the SEC greater authority to establish standards for clearinghouses.

In general, clearing agencies act as middlemen to the parties in a securities transaction. They play a crucial role in the securities markets by ensuring the successful completion of operations and avoiding the risk of a defaulting operator.  In addition, they ensure transactions are settled on time and on the agreed-upon terms.

The rule is similar to the Supervisory Capital Assessment Program, publicly described as the bank “stress tests.”  This examination, conducted by the Federal Reserve System, measured the financial strength of the nation’s 19 largest financial institutions.  The stress tests measured whether banks had enough capital to weather a downturn with enough funds to continue lending.  Like the new Rule, the stress tests were intended to reduce uncertainty surrounding the financial system, while building up transparency and investor confidence.

Under the new Rule, clearing agencies will have to maintain sufficient financial resources to withstand, at a minimum, a default by the participant group to which it has the largest exposure in extreme (but plausible) market conditions.  In addition, the clearing agencies will now be required to calculate and maintain a record of the financial resources that would be needed in the event of a participant default.  Clearing agencies must perform the calculation quarterly, or at any time upon the SEC’s request, and must post on their websites annual audited financial statements within 60 days of fiscal year-end.

The Rule also requires clearing agencies to implement membership standards for central counterparties reasonably designed to: 1) provide membership opportunities to persons who are not dealers or security-based swap dealers, 2) not require minimum portfolio size or transaction volume. Those who have a $50 million portfolio should also be able to obtain membership, provided they comply with other reasonable membership standards.