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.

Firm Advice: Your Weekly Update

By jsantiesteban | Posted on

On December 3rd, the SEC approved FINRA Rule 5123, which requires firms that sell a security in a private placement to file with FINRA a copy of any private placement memorandum, term sheet or other offering document used by the firm within fifteen days of the sale. The Rule provides for limited exemptions. FINRA also issued “frequently asked questions” regarding the substantive and procedural requirements of the filings. Morrison & Foerster has summary of these requirements and exemptions in a recent News Bulletin.

On December 6, 2012, the SEC lifted the two-year-old moratorium on active exchange-traded funds’ (“ETF”) use of derivatives. The news came during a speech by Norm Champ, the SEC’s Director of the Division of Investment Management. During the moratorium, the SEC would only approve ETFs that represented that they did not make any investments in options, futures, or swaps. In a recent Legal Update, Dechert discusses the implications and limitations of the proposal.

Proprietary Data Feeds and the SEC’s Regulatory Approach to High Frequency Trading

By Andrew Sioson, J.D. Candidate 2013 | Posted on

Earlier this year the Securities Exchange Commission (“SEC”) levied its first monetary fine against an exchange as part of a $5 million dollar settlement against the New York Stock Exchange (“NYSE”).  The SEC found that the NYSE delivered stock-price quotes and other data to subscribers of so called proprietary data feeds seconds before transmitting the same data to the broader market.  This gave certain traders an improper head start to act on important market information.  Proprietary data feeds had been a favorite resource of high frequency trading (“HFT”) firms whose business model depends on split-second informational advantages.  The SEC’s attack on proprietary feeds represents an episode in the struggle to regulate HFT.

HFT firms use computer-based algorithms and ultra-fast processing speed to steer daily trading activity.  They derive profits by obtaining information about the market and executing trades much faster than non-HFT competitors.  Typically, HFT firms would have to wait for public disclosure of market data before trading on such information because U.S. exchanges are required to submit market data to a centralized network for public dissemination.  However, proprietary feeds, like the ones offered by NYSE, allowed firms direct access to information a few seconds before public disclosure.  According to Gibson Dunn Partner Barry Goldsmith, permitting access to these NYSE feeds gave HFT firms “potentially unfair advantages.”

Some critics go further than Goldsmith and question whether HFT should be allowed at all.  These critics argue that HFT creates two-tiered markets where firms with fast computers trade ahead of market orders to the detriment of all other investors.  Even without the NYSE feeds, HFT firms use sophisticated infrastructure to routinely access market data before non-HFT firms. Some strategies include issuing thousands of “immediate or cancel” orders and dark pool pinging.  Furthermore, proliferation of HFT practices has been recognized as a cause of the 2010 “Flash Crash” and other market embarrassments like the Knight Capital “Trading Glitch.”

Despite evidence of HFT’s negative impact on markets, the practice does have support.  HFT’s proponents claim that the practice has positive effects.  Cameron Smith, General Counsel for Quantlab Financial, argues that HFT increases liquidity by increasing trading volumes, thus making it easier to find buyers and sellers of securities. This increased liquidity also lowers trading costs by reducing risk for market makers.  Accordingly, Smith believes that HFT firms should not be inhibited by regulation.

The SEC appears content with an intermediate position, allowing HFT firms certain privileges, like server collocation, while directly attacking certain methods it deems as abusive informational advantages, like flash trading and utilization direct data feeds.  Though the NYSE settlement and fines may curb the aggressive marketing of data feeds to HFT, unbalanced informational advantages for HFT and market failure risks still remain.  The SEC must make difficult decisions in considering what types of advantages it will allow to HFT.  As European regulators move to halt HFT completely, it remains to be seen whether the SEC will change its regulatory approach.

Firm Advice: Your Weekly Update

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

Federal Reserve Governor, Daniel Tarullo, recently discussed an upcoming proposal to alter the regulation of foreign banks in the U.S. The proposal would require large foreign banks to establish “a separately capitalized top-tier U.S. intermediate holding company.” The holding company would be “required independently to meet all U.S. capital and liquidity requirements as well as other enhanced prudential standards required by the Dodd-Frank Act.” In a recent Client Memorandum, Davis Polk suggests that the proposal “could have profound negative consequences” for both foreign banks in the U.S. and U.S. banks abroad by adding “fuel to the growing trend toward regionalization of global banking.” The proposal is still under consideration and more details are anticipated “in the coming weeks.”

The Dodd-Frank Act amended the Commodities Exchange Act to require clearing of certain swaps through a derivatives clearing organization. This includes fixed-to-floating swaps, basis swaps, forward rate agreements, and overnight index swaps. The CFTC recently issued final rules to implement this requirement and issued two no-action letters “that provide time-limited relief from the clearing requirement for certain swaps.” In a recent Legal Alert, Bingham McCutchen details the requirements, the timing of their implementation, and safe harbors provided by the no-action letters.

In a recent Corporate Finance Alert, Skadden provides guidance on how to avoid prohibited communications when contemplating a securities offering. Section 5 of the Securities Act prohibits “activities intended to stimulate interest in a securities offering prior to the filing of registration statement.” Violations of this prohibition are commonly referred to as “gun jumping.” The Alert outlines the types and timing of permitted and prohibited communications, as well as suggestions for a company policy on relevant social media communications.

Saudi Arabia’s Real-Estate Finance Laws

By Maha Al-fozan, LL.M. Candidate 2013 | Posted on

In July 2012, Saudi Arabia witnessed the official launch of the real-estate finance industry as part of the country’s economic financial development plans.  To promote the local competition between banking and other financial sectors, and the economy’s overall global competitiveness, non-banking corporations may now finance real estate in Saudi Arabia.

The Real Estate Development Fund (“REDF”) is the country’s main provider of housing finance.  REDF was unable to meet the rapidly increasing demand, while other real estate financing was limited due to absence of a well-structured regulatory framework.  For example, the industry lacked effective land registries and foreclosure regulations for properties in default.  Individual real estate financing was done against the transfer of title deeds rather than as an official mortgage.  In addition, lenders have been conservative with their loan standards, resulting in a low mortgage penetration rates.

Making mortgages available to public will address the imbalances occurring in the market with supply twisted to the high end.  The new Saudi laws tackle the chronic shortage of home ownership, particularly in the affordable middle- and lower-end markets.  More financing opportunities are needed, even though additional time may be required for the market to safely adopt such laws.

These laws are tools to open safe and continuous investment channels.  They encourage national economy leaders to diversify income sources and create job opportunities and investments in the country.  They also satisfy growing demands for appropriate and safe housing offers.  These steps aim to develop mechanisms that preserve homeownership rights, while stimulating financial institutions to lend more frequently, reduce the cost of mortgage financing and provide differentiated products for multiple segments of society.

(more…)

Firm Advice: Your Weekly Update

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

Recently, the DOJ and SEC issued A Resource Guide to the U.S. Foreign Corrupt Practices Act. The FCPA prohibits U.S. persons and businesses and all companies listed on U.S. stock exchanges from making corrupt payments to foreign official to obtain or retain business. The FCPA also mandates that these companies maintain accurate books and a system of internal accounting controls. The goal of the Resource Guide is to help companies “abide by the law, detect and prevent FCPA violations, and implement effective compliance programs.” The Resource Guide explains the intricacies of which companies are subject to the law and the types of transactions are likely to violate the law. In a recent Client Alert, Latham & Watkins provides a summary of the Resource Guide and the nine most relevant and important areas. The Client Alert is available for download here.

The Fiscal Cliff is looming in 2013, and with it is the specter of increased taxes. Both the cliff itself and any potential compromise are likely to include increased marginal tax rates and capital gains taxes.  While some people may wish to accelerate income into 2012 to avoid the increased taxes, Section 409A of the Internal Revenue Code severely limits the “ability of employers and employees to change the time of payment for most types of compensation.” In a recent Client Alert, Skadden presents “Strategies for Accelerating Incoming into 2012,” focusing on methods of accelerating income that avoid the limitations of 409A.

The U.S. Secretary of the Treasury recently exempted foreign exchange swaps from certain regulations under the Commodity Exchange Act. These swaps will not be subject to central clearing, margin or exchange trading requirements.  In a recent Client Alert, Mayer Brown explains the qualifications for foreign exchange swaps and the consequences of their exemption.