On October 26th the SEC closed debate on a proposal to adopt “seasoning” requirements for companies listed on public exchanges, such as NASDAQ and NYSE. The proposed seasoning requirements aim to protect investors from a rash of accounting scandals perpetrated by companies that have avoided normal reporting and auditing requirements through the strategic use of reverse mergers. Many of the companies that have been engaging in reverse mergers and perpetrating these accounting scandals have been based in China, which have caused US investors to flee from Chinese equities.
Seasoning Requirements: Regulating Chinese Companies And Reverse Mergers
Update: 298 Page Volcker Rule Proposal Leaves Much To Be Desired (And Decided); Issue #1: Market Making
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.
Flying Under the Radar, New Municipal Advisor Rules May Alter the Municipal Securities Landscape
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.
Will Concepcion Allow Arbitration Agreements to Squash Consumer Class Actions?
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)
The Effects of Upcoming SEC Regulations Governing Accredited Investor Status
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.
Dodd-Frank One Year Later: A Lot of Unfinished Business
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:
Transparent Oil: New Dodd-Frank Requirements
Written by Anderson Franco & Angélica Salceda
Theoil industryhas recently criticized the Dodd-Frank Act’s oil and gas reporting rules by claiming that the transparency requirements will result in restrained money flows between oil companies and governments. Under Dodd-Frank, all oil, gas and mining companies registered with the SEC must report payments to foreign governments on a country-by-country, and project-by-project basis.
The transparency requirements will provide detailed, standardized, and comparable data that will pressure governments to improve their revenue reports and strengthen oversight. Critics claim that the disclosures required by Dodd-Frank undermine the voluntary standard established by theExtractive Industries Transparency Initiative(EITI).
TheEITIis a global standard that promotes revenue transparency and provides a methodology for monitoring and reconciling company payments and government revenues. Nevertheless, only 11 of the 35 EITIimplementing countries fully comply with the requirements.
SEC Rolls Out the “Skin in the Game” Regulation to Mitigate Moral Hazard for Lenders and Bond Issuers Involved in Asset-Backed Securities
On March 31 the SEC began seeking public comment on its proposed “skin in the game” regulation, which would require lenders and bond issuers of asset-backed securities (ABS’s) to retain 5% of the credit risk of the securities they issue. This requirement would apply to each of the tiers of ABS’s issued individually, preventing a lender or bond issuer from issuing a large proportion of risky securities and yet only retaining its 5% stake in those safer, higher-grade securities it issues. In the alternative, a lender or bond issuer could also comply with the regulation by retaining 5% of the first-loss residual interest of all ABS’s issued or a 5% interest in a representative sample of the underlying securities.
The rule is one of the many proposed by the SEC in accordance with the mandates of the Dodd-Frank Act. The rule was motivated by the public perception that there was an incentive problem, often referred to as a moral hazard, inherent in lending practice that became hegemonic in the mortgaged-backed securities (MBS’s) market. The potential problem lies in the fact that the banks and lenders extending loans to home buyers may not fully appreciate the credit risk of doing so because of their ability to turn around and easily sell these mortgages on the secondary market (commonly referred to as the “originate-and-distribute” model). Large financial institutions, acting as intermediaries between these lenders and investors, would buy mortgages and combine many of them into an investment tool, dividing the pool of mortgages into traunches (with returns on investment commensurate with the perceived security of the traunch invested in). While this securitization process is effective at providing greater liquidity in the mortgage market (as more investors will be willing to invest in the industry if the risk of default can be managed and mitigated through diversification and stratification inherent in the securitization process) the process also debased the incentive for lenders and bond issuers to ensure that borrowers were truly credit-worthy and able to sustain their mortgage payments.
Don’t Count Me In: Firms Scramble to Avoid Making the “Systemically Important” List
As reported in a previous post on this forum (see Fed Proposes Definitions for Systemically Important Nonbank Financial Institutions) the Fed proposed a rule on February 8th regarding when a company would be considered “systemically important.” This rule is significant because the designation would be accompanied by a large number of regulatory requirements (which would be accompanied by increased compliance costs), including the ominous authority/responsibility the FDIC will have to “wind down” the company in the event it nears failure.
Financial institutions are now engaged in a major lobbying effort to shape the definition of systemically important institutions in order to avoid the accompanying regulatory requirements. The decision is left up to the Financial Stability Oversight Council, which is scheduled to discuss this issue at its next meeting in May. Large bank holding companies, such as Bank of America, are clearly set to come under the umbrella of the regulation, due to the size of the assets they control (greater than $50 billion). However, insurance companies that fall under this threshold are looking to avoid the list, arguing that they do not present the same systemic risks that banks do because they are not susceptible to a run on their assets.
Let the Delegation Continue: Supreme Court Reaffirms Deference to Administrative Agencies in Regulatory “Interpretation” of Statutes
On January 11th the Supreme Court handed down its decision in Mayo v. U.S. The decision reaffirmed the Court’s use of the Chevron standard, under which government agencies are given broad authority to make any “reasonable interpretations” of statutes so long as Congress does not specifically and clearly address the issue in the relevant legislation. The decision is significant because lower courts had previously spliton whether the Treasury Department, in implementing the Internal Revenue Code (IRC), was subject to the more exacting standard found in National Muffler. Under the National Muffler standard, government agencies’ only had the latitude to make interpretations that “harmonize with the plain language of a statute, its origin, and its purpose.”
In Mayo v. U.S. the plaintiff, Mayo Foundation for Medical Education and Research, was challenging a Treasury Department regulation that would classify medical residents (individuals that have recently graduated from medical school and seek additional instruction in a specialization) as employees. The Treasury Department implemented this regulation pursuant to a statutepassed by Congress, which exempted from consideration as employees individuals whose “services performed in the employ of… a school, college, or university… if such service is performed by a student that is enrolled and regularly attending classes at [the school].” Dating back to 1951 the Treasury Department had exempted students (including medical residents) from being classified as employees of schools, colleges, and universities, if their work was “incident to and for the purpose of pursuing a course of study.” However in 2004 the Treasury Department passed a regulationthat eliminated this exemption for “students” that worked 40 hours per week or more. Utilizing the Chevron standard, the Court in Mayo concluded that it was reasonable for the Treasury Department to change course and consider individuals working 40 hours or more per week as not “regularly attending classes.”