Insights from Winston & Strawn

On December 3, the Consumer Financial Protection Bureau (CFPB) issued its Second Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (CARD Act) report on the credit card market.  Federal law requires the CFPB to report every two years on this subject. 

The 300-page report found rewards programs, deferred interest products, subprime credit cards, ability to pay, add-ons, and debt collection to be “areas of concern;” each likely will be the subject of both examiner scrutiny and enforcement action. 

As to credit card rewards programs, the CFPB believes that customer confusion is caused by the marketing of how points are earned; what constitutes “inactivity;” and that, and how, points expire, and the CFPB suggests this may be unfair or deceptive.  Even after marketing, i.e. at account opening, this information may not all be in one place where a consumer may easily look.  The CFPB also expressed concern about issuers having the authority to change rewards programs without notice, shortening expiration periods or increasing the number of points required to redeem.  Concern was also expressed about rewarding the amount outstanding revolving on the card.  The CFPB also expressed concern about marketing ease of redemption of rewards as there are often limits on redemption.  Some of these concerns may be difficult for issuers of co-branded cards to address without the cooperation of their partners.  

The CFPB also expressed serious concern about deferred interest programs, i.e. where accrual of interest is deferred if payments of certain amounts are made by a fixed date.  Where such  payments are missed, the customer is suddenly confronted with a much higher repayment obligation. The CFPB believes that one quarter of private label spending is on deferred interest accounts and that interest rates may be higher on such accounts.  The CFPB is concerned about the ability of consumers to repay credit card debt, and increases in payment obligations triggered by missed deferred interest deadlines obviously affects that analysis.  The CFPB also is concerned about what it calls “back-end pricing” as originally stated initial interest rates are understated to the consumer because those rates do not reflect the reality of triggers that can increase the effective interest rate.  The CFPB believes that many consumers over-estimate their ability to make the total payment by the fixed date and that card issuers may be exploiting that human foible.  It believes that current disclosure requirements are insufficient in this area if only because consumers do not understand how payments are allocated by card issuers.

Credit card rewards programs and deferred interest programs are likely to be bright on the CFPB’s examination and enforcement radar in the next 12 months.

Feature: Recent U.K. Developments

The U.K. Financial Conduct Authority (“FCA”)

The FCA issued final rules for the new accountability framework for individuals working in U.K. branches of overseas banks (“incoming branches”) in a policy statement published on December 16th. The FCA published near-final rules in August 2015 to assist incoming branches with the March 2016 implementation of the Senior Managers Regime (“SMR”), Certification Regime (“CR”) and Conduct Rules while awaiting action by the U.K. government on legislation formally extending the regime to incoming branches. The FCA delayed publication of the final rules until after this legislation went into effect on November 9, 2015. The final rules, which largely reflect the proposed rules that were published for consultation in March 2015, further include some changes to clarify the territorial scope of the CR and Conduct Rules in an effort to prevent the rules from applying to those based overseas who do not engage in activities clearly linked to an incoming branch. The final rules for the new accountability framework for individuals working in U.K. branches of overseas banks will become effective on March 7, 2016.  

In tandem with the publication of these final rules, the FCA also released a policy statement on December 16th containing the final rules implementing the Senior Insurance Managers Regime (“SIMR”) for insurance firms not subject to Solvency II, or Non-Directive Firms. Those final rules mirror the draft rules that were set out in a revised consultation paper in August 2015. The FCA noted that implementation of the SIMR will not be affected by the U.K. government’s announcement that it will extend the requirements of the SMR and CR beyond the banking sector to all financial firms, and encouraged insurers to prepare for the final rules implementing SIMR for Non-Directive Firms, which will become effective on March 7, 2016.  

One day earlier, on December 15th, the FCA published its first consultation paper on the implementation of the new Markets in Financial Instruments Directive II (“MiFID”), the revised version of the E.U.’s directive creating a single market and regulatory framework for investment services and activities in Europe. This consultation paper contains proposals related to the FCA’s regulation of the secondary trading of financial instruments, including trading venues, transparency of trading and algorithmic and high frequency trading. Comments should be submitted by March 8, 2016.  

Earlier this month, the FCA released the findings of its review of wealth management and private banking firms that focused on the suitability of retail investment portfolios. The review was prompted by concerns raised during previous FCA reviews that firms in the wealth management industry were unable to demonstrate the suitability of their retail customers’ investment portfolios due to poor recordkeeping and that the retail investment portfolios at these firms were at greater risk of unsuitability due to inconsistencies between portfolios and the customer’s attitude to risk and investment objectives. In its latest thematic review, published on December 9th, the FCA noted that while some firms have made improvements in demonstrating the suitability of their customers’ investment portfolios, many firms need to take steps to improve their practices of gathering, recording, and updating customer information to support their investment portfolios.  

On December 8th, the FCA took steps to address deficiencies in another area of the financial sector by publishing data from its cash savings market study that reveals the lowest interest rates available on cash savings accounts. The data was released along with final rules that seek to improve competition for cash savings accounts by providing consumers with more information and streamlining the process for switching accounts. These new final rules, which will become effective on December 1, 2016, will require firms to make clear disclosures to consumers regarding interest rates and other product information and to provide prompt and efficient service when customers request to switch to a better account offered by the same firm.  

Also on December 8th, the FCA published a policy statement containing final rules and changes to its Handbook relating to the introduction of new capital resource requirements for personal investment firms (“PIFs”). The rules establish a minimum amount of capital resources these firms must retain to help them absorb routine losses and meet redress claims against them, setting the requirement at the higher of £20,000 or a variable requirement of five percent of a firm’s investment business annual income. This requirement will become effective on June 30, 2016, along with most of the Handbook changes. To coincide with a new capital framework for self-invested personal pension operators, changes to the requirements for PIFs to establish, operate or wind up a personal pension scheme will be delayed until September 1, 2016.  

And finally, last month, the FCA requested comment on a consultation paper that proposes amendments to its guidance about delaying the disclosure of inside information in its Disclosure and Transparency Rules. The proposal seeks to clarify guidance concerning when issuers with securities admitted to trading on a regulated market may legitimately delay disclosure of inside information. The FCA will accept comments on the proposal submitted on or before February 20, 2016.

Prudential Regulation Authority (“PRA”)

In conjunction with the FCA, the PRA published its own policy statement related to the SMR and CR on December 16th, which sets out the final rules regarding the application of the regimes to U.K. branches of non-European Economic Area (“non-EEA”) banks and PRA-designated investment firms (“non-EEA branches.”) The final rules in the policy statement are identical to the near-final rules published by the PRA in August, which extend the accountability regimes to non-EEA branches. The policy statement also includes a finalized supervisory statement that explains the PRA’s expectations regarding how non-EEA branches should comply with certain elements of the new regimes.  

Last week, the PRA requested comment on a consultation paper that contains proposals regarding the relationship between the minimum requirement for own funds and eligible liabilities (“MREL”) and risk-weighted capital buffers and leverage buffers, as well as the relationship between MREL and PRA’s Threshold Conditions, which establish the minimum requirements for firms to meet to continue engaging in regulated activities. Among other things, the PRA’s proposals would prevent firms from applying common equity tier 1 (“CET1”) capital towards both MREL and risk-weighted capital and leverage buffers. Comments on this consultation paper should be submitted on or before March 11, 2016.  

Earlier this month, the PRA issued a suite of policies implementing a U.K. leverage ratio framework to address the risk of excessive leverage for the most systemically-important firms. The final rules, set out in a policy statement published on December 7th, would apply to PRA-regulated banks and building societies with retail deposits equal to or greater than £50 billion. These firms would be required to meet a three percent minimum leverage ratio requirement and hold an amount of CET1 capital that is greater than or equal to their countercyclical leverage ratio buffer. Additional requirements would apply to global systemically important institutions. All firms falling in the scope of the requirements would be subject to leverage ratio reporting and disclosure requirements. Along with the policy statement, the PRA released a supervisory statement explaining its expectations under the framework for Capital Requirement Regulation firms as well as a supervisory statement explaining the data items that should be included in a leverage ratio report.

Bank of England (“BOE”)

At the beginning of December, the BOE’s Financial Policy Committee (“FPC”) released its highly-anticipated Financial Stability Report. This semi-annual report examines the risks faced by the U.K. financial system and weighs those risks against an assessment of the system’s resilience to determine the outlook for financial stability in the U.K. According to the report, the greatest risks to the U.K. financial system include risks to the global macroeconomic environment arising from emerging market economies; asset prices that are vulnerable to a sharp increase in market interest rates; the high current account deficit; and cyber risks. The report concludes that the U.K. banking sector has become more resilient, as evidenced in the results of the 2015 annual stress test, which indicated that the banking system would have the capacity to maintain its core functions under the tested scenario. As a result, the report concludes that the U.K. financial system has moved out of the post-financial crisis period.

Banking Agency Developments

OCC

Federal Banking Agencies Seek Comment on Interagency Effort to Reduce Regulatory Burden

On December 17th, the Office of the Comptroller of the Currency (“OCC”) announced that the federal banking agencies have approved a notice requesting comment on the fourth and final set of regulatory categories as part of their review to identify outdated or unnecessary regulations applied to insured depository institutions. OCC Press Release.

OCC Requests Comment on Proposed Rule to Establish Enforceable Guidelines for Recovery Planning

On December 17th, the OCC announced that it is requesting comment on a proposed rule to establish enforceable guidelines for recovery planning by insured national banks, insured federal savings associations, and insured federal branches of foreign banks with average total consolidated assets of $50 billion or more (covered banks). The guidelines are issued pursuant to a federal statute that authorizes the OCC to prescribe operational and managerial standards for national banks and federal savings associations. The OCC guidelines would be enforceable under the terms of that statute. The comment period for the proposed rule ends February 16, 2016. OCC Bulletin.

OCC Report Highlights Top Risks Facing National Banks and Federal Savings Associations

On December 16th, the OCC announced that it released its “Semiannual Risk Perspective for Fall 2015,” which notes that the risks associated with underwriting and cybersecurity are increasing, while strategic, compliance, and interest rate risks remain stable. OCC Press ReleaseCurry Remarks.

Treasury Department Developments

FinCEN

FinCEN Invites Nominations for Membership on Bank Secrecy Act Advisory Group

On December 17th, the Financial Crimes Enforcement Network (“FinCEN”) invited the public to nominate financial institutions and trade groups for membership on the Bank Secrecy Act Advisory Group. New members will be selected for three-year membership terms. Nominations must be received by January 19, 2016. FinCEN News.

CFPB

CFPB Announces New General Counsel

On December 16th, the Consumer Financial Protection Bureau (“CFPB”) announced that Mary McLeod will join the Bureau as General Counsel, upon the departure of current General Counsel and Acting Deputy Director Meredith Fuchs in early 2016. CFPB Press Release.

CFPB Releases Tool to Help Measure Financial Well-Being

On December 11th, the CFPB announced its release of a tool to measure consumer financial well-being, based on a definition that the Bureau released in January 2015. This first-of-its-kind tool provides questions that educators and others working to build financial capability can use to accurately and consistently quantify the financial well-being of consumers. CFPB Press Release.

Securities and Exchange Commission

Final Rules

SEC Adopts Revisions to EDGAR Filer Manual and Rules

The Securities and Exchange Commission (“SEC”) issued a final rule on December 11th adopting revisions to the EDGAR Filer Manual and related rules to reflect updates to the EDGAR system. Among other things, the changes reflected in the revised EDGAR Filer Manual include new form types associated with the recently adopted Regulation Crowdfunding, updates to Regulation A form submission types, and new electronic form types for broker-dealers to submit annual reports and amendments to annual reports. The final rule will be effective upon publication in the Federal Register with changes reflected in the EDGAR system on December 14, 2015. SEC Release No. 33-9987.

Proposed Rules

SEC Proposes Format for Submission of Electronic Security-Based Swap Data by Repositories

The SEC requested comment on a proposed amendment to Securities Exchange Act Rules 13n-1 to 13n-11, which govern the registration, duties, and core principles of security-based swap data repositories (“SDRs”). The proposed amendment, published on December 11th, would establish the form and manner in which SDRs would be required to make security-based swap (“SBS”) data available in electronic format to the SEC by using appropriate schemas available on the SEC website and will rely on either FpML or FIXML. Comments should be submitted within 60 days of publication in the Federal Register, which is expected shortly. SEC Release No. 34-76624.

Exemptive Orders

SEC Approves Third Avenue’s Request to Suspend Redemptions Temporarily

The SEC issued a notice of application and temporary order on December 16th that permits Third Avenue Focused Credit Fund to suspend the right of redemption of its outstanding redeemable securities. The SEC issued the temporary order after reviewing an announcement by the Fund and its investment adviser, Third Avenue Management LLC, that it had adopted a liquidation plan for the Fund in response to an ongoing reduction in liquidity in the Fund’s portfolio securities due in part to a significant number of redemption requests over the past six months. Hearing requests should be received by the Commission by 5:30 pm on January 7, 2016. SEC Release No. IC-31943. According to a report in Bloomberg, the SEC balked at Third Avenue’s liquidation plan, which would have established a liquidating trust to sell its holdings and prevented customers from withdrawing their funds immediately, because Third Avenue did not reveal its plan to the SEC until the last minute.

Speeches and Statements

Aguilar Encourages SEC to Balance Data Needs with Cybersecurity Protocols

In a statement published on December 16th, SEC Commissioner Luis A. Aguilar provided an overview of the SEC’s recent data gathering efforts, the SEC’s need to collect and analyze this data, the potential cybersecurity threats the SEC may face as a result of its data gathering activities, and the steps the SEC should consider to mitigate these potential cybersecurity threats. Aguilar Statement.

Grim Highlights Transition Planning, Stress Testing Among 2016 Rulemaking Initiatives

In remarks to the Investment Company Institute 2015 Securities Law Development Conference delivered on December 16th, SEC Division of Investment Management Director David Grim provided an overview of rulemaking initiatives pursued by the SEC in 2015 that impact the asset management industry and offered a preview of rulemaking initiatives under consideration in 2016. Among other things, Grim noted that the Division of Investment Management is considering making recommendations to the Commission that would require investment advisers to devise and maintain transition plans in the event of a major business disruption and that would establish new requirements for stress testing by large investment advisers and investment companies.Grim Remarks.

Other Developments

SEC Staff Report on the Accredited Investor Definition

The SEC published a report prepared by staff from the Divisions of Corporation Finance and Economic Risk and Analysis on the accredited investor definition on December 18th. The report, which was prepared in connection with the first review of the definition as mandated by the Dodd-Frank Act, examines the history of the accredited investor definition, considers comments on the definition received from a variety of sources, and provides staff recommendations for potential updates and modifications to the definition. Staff recommendations include, among others, leaving current income and net worth thresholds in place, but limiting investments to a percentage of income or net worth for those who qualify solely based on those thresholds; adding new inflation-adjusted income and net worth thresholds that are not subject to investment limitations; and replacing the assets test in the current definition with an investments test to permit entities with investments in excess of $5 million to qualify as accredited investors. The SEC has requested comment on the report and staff recommendations. SEC Press Release.

SEC Allows Companies to Test File Regulation Crowdfunding Form

The SEC’s Division of Corporation Finance announced on December 18th that the SEC will offer test filings of Regulation Crowdfunding Form C, which companies seeking to conduct a crowdfunding offering must file to make require disclosures in connection with the offering. Companies can access Form C on the SEC’s EDGAR filing website provided they have a Central Index Key (“CIK”) and a CIK Confirmation Code (“CCC”). Companies must identify their Form C filings as “test” filings during the testing period, which will be held now through February 29, 2016. SEC Press Release.

Commodity Futures Trading Commission

Staff Advisory

CFTC Staff Reminds Swap Dealers and Major Swap Participants of Their Reporting Obligations

On December 17th, the Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued a staff advisory to remind swap dealers and major swap participants of their swap data reporting obligations under the Commission Regulations 23.204 and 23.205. These regulations require swap dealers and major swap participants to report all information and data in the time and manner specified in Parts 43 and 45 of the CFTC’s regulations. The staff advisory also discusses common examples of issues and failures that the DSIO has observed with respect to swap data reporting, and provides guidance to assist in addressing these issues and failures. CFTC Press Release.

Final Rules

CFTC Approves Final Rule on Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants

On December 16th, the CFTC announced that it approved the Final Rule on Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants. The new regulation addresses margin requirements for uncleared swaps entered into by swap dealers (“SDs”) or major swap participants (“MSPs”) that are not subject to regulation by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration or the Federal Housing Finance Agency. Final Rule Fact SheetMassad StatementBowen Dissenting StatementGiancarlo Statement.

Proposed Rules

CFTC Proposes Series of Risk Controls, Transparency Measures, and Other Safeguards to Enhance Regulatory Regime for Regulation Automated Trading

On December 17th, the CFTC proposed a series of risk controls, transparency measures, and other safeguards to enhance the regulatory regime for automated trading on U.S. designated contract markets (‘‘DCMs’’) (collectively, ‘‘Regulation AT’’). The CFTC’s proposals build on efforts by numerous entities in recent years to promote best practices and regulatory standards for automated trading, including standards and best practices for algorithmic trading systems (‘‘ATSs’’), electronic trade matching engines, and new connectivity methods that characterize modern financial markets. Comments must be received on or before March 16, 2016. CFTC Proposal.

CFTC Unanimously Approves Proposed Enhanced Rules on Cybersecurity for Derivatives Clearing Organizations, Trading Platforms, and Swap Data Repositories

On December 16th, the CFTC voted unanimously to approve two proposals for amendments to existing regulations addressing cybersecurity testing and safeguards for the automated systems used by critical infrastructures that the CFTC regulates. The proposals will be open for public comment during a 60-day comment period after their publication in the Federal Register. The proposals, to be published in separate Federal Register Notices, identify five types of cybersecurity testing as essential to a sound system safeguards program: vulnerability testing, penetration testing, controls testing, security incident response plan testing, and enterprise technology risk assessments. The two proposals would require all derivatives clearing organizations, designated contract markets, swap execution facilities, and swap data repositories to conduct each of the five types of cybersecurity testing, as frequently as indicated by appropriate risk analysis. In addition, the proposals would specify minimum testing frequency requirements for all derivatives clearing organizations and swap data repositories and specified designated contract markets, and require them to have certain tests performed by independent contractors. Massad StatementGiancarlo StatementBowen Statement.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Financial Industry Regulatory Authority

SEC Approves FINRA Plan to Merge Its Dispute Resolution and Regulatory Subsidiaries

On December 16th, the SEC approved the Financial Industry Regulatory Authority’s (“FINRA”) proposed rule change that would merge its dispute resolution subsidiary, FINRA Dispute Resolution, Inc., with its regulatory subsidiary, FINRA Regulation, Inc., and make additional conforming amendments to FINRA rules. SEC Release No. 34-76670.

FINRA Task Force Makes Recommendations to Improve Dispute Resolution Process

FINRA published the final report and recommendations of its Dispute Resolution Task Force on December 16th. FINRA formed the task force to recommend strategies to enhance the transparency, impartiality and efficiency of FINRA’s dispute resolution forum. The task force’s recommendations include increasing the amount of the arbitrator honoraria, including a single party opt-out provision in explained decisions, creating a pool of trained arbitrators to conduct expungement hearings, and creating an automatic mediation process for cases filed in arbitration. FINRA Press Release.

FINRA Proposal to Apply Mark-Ups and Commissions Rules to Government Securities Transactions Approved by SEC

On December 14th, the SEC approved FINRA’s proposed rule changes that would apply FINRA rules governing mark-ups and commissions to transactions in, and business activities related to, exempted securities that are government securities. SEC Release No. 34-76639.

International Swaps and Derivatives Association

ISDA Announces Commitment by Member Firms to Single-Name CDS Clearing

On December 16th, the International Swaps and Derivatives Association, Inc. (“ISDA”), along with the Managed Funds Association (“MFA”) and the Securities Industry and Financial Markets Association’s (“SIFMA”) Asset Management Group, announced that 25 of their collective members have agreed to commence clearing their single-name credit default swap (“CDS”) trades through central counterparties (“CCPs”). The voluntary agreement seeks to enhance the transparency and efficiency of single-name CDS and to encourage a strong marketplace that can be accessed to manage credit risk. ISDA Press Release. 

National Stock Exchange, Inc.

NSX Approved by SEC to Resume Trading Activity

On December 14th, the SEC approved the National Stock Exchange, Inc.’s (“NSX”) proposal to amend its rules to allow trading activity to resume on the exchange. The SEC noted in approving the proposal that NSX is positioned to resume its status as a fully operational national securities exchange and its staged roll-out plan will ensure trading is resumed in an orderly manner. SEC Release No. 34-76640.

NASDAQ OMX Group

SEC Designates Longer Period to Consider Changes to Phlx’s Complex Order Rules

On December 15th, the SEC designated February 18, 2016, as the date by which it will approve or disapprove NASDAQ OMX PHLX LLC’s (“Phlx”) proposed rule change that would amend and correct several provisions in its rules governing the trading of Complex Orders on Phlx XL. SEC Release No. 34-76648.

National Securities Clearing Corporation

NSCC Approved to Implement Sub-Account Settlement for AIP Fund Administrators

On December 15th, the SEC announced that it has approved a proposed rule change filed by the National Securities Clearing Corporation (“NSCC”) that would allow Fund Administrators of NSCC’s Alternative Investment Product Services (“AIP”) to create sub-accounts that settle separately from their primary AIP accounts and other AIP sub-accounts. SEC Release No. 34-76652.

NYSE

NYSE Arca Proposes Price Collar Thresholds for Trading Halt Auctions in Response to Market Volatility

On December 18th, the SEC requested comment on a proposed rule change filed by NYSE Arca, Inc. (“NYSE Arca”) that would amend its rules to provide price collar thresholds for Trading Halt Auctions. The proposed amendments respond to the market volatility experienced on August 24, 2015, and would specify percentages for the price collar thresholds for Trading Halt Auctions at 10 percent for securities with a consolidated last sales price of $25.00 or less, five percent for securities with a consolidated last sales price greater than $25.00 but less than or equal to $50.00, and three percent for securities with a consolidated last sales price greater than $50.00. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of December 21, 2015. SEC Release 34-76690.

NYSE Designates December 28th as Last Trade Date for ‘Regular Way’ Settlement in 2015

On December 15th, the New York Stock Exchange, LLC (“NYSE”) announced that December 28, 2015, will be the last day this calendar year on which “regular way” transactions in securities, other than U.S. government obligations, may be made for settlement on NYSE and NYSE MKT LLC (“NYSE MKT”). Non-regular way transactions effected between December 29 and December 31, 2015, for settlement in 2015 may be effected on “cash,” “next day,” or “seller’s option” basis. NYSE Information Memo 2015-10.

SEC Takes More Time to Consider Changes to NYSE Exchanges’ Off-Exchange Transaction Reporting Requirements

On December 16th, the SEC designated January 31, 2016, as the date by which it would either approve, disapprove, or institute disapproval proceedings regarding NYSE’s and NYSE MKT’s separately filed proposals to delete their respective rules governing the reporting requirements for off-Exchange transactions.

Options Clearing Corporation

OCC Requests No Objection from SEC to Proposal Extending Existing Confirmation for Non-Bank Liquidity Facility

On December 14th, the SEC provided notice of The Options Clearing Corporation’s (“OCC”) filing of an advance notice in connection with proposed rule changes concerning the OCC’s Non-Bank Liquidity Facility. The advance notice requests that the SEC not object to the proposed changes for renewing, in the future, the Existing Confirmation of the Non-Bank Liquidity Facility and the Second Confirmation on the same terms and conditions with the same Counterparty without filing an advance notice concerning the renewal, subject to certain conditions. Comments should be submitted on or before January 4, 2016. SEC Release No. 34-76641.

Judicial Developments

Paramount Pictures Did Not Change its Business Strategy Following Investment Transaction

Investors in a special purpose vehicle that invested its funds in films produced and distributed by Paramount Pictures brought claims for federal securities fraud, common law fraud, and unjust enrichment, arguing that the district court erred in finding that Paramount’s business strategy as to film financing and risk mitigation did not change following their investment. The Second Circuit affirmed on December 14th, holding that the district court’s ruling that Paramount did not change its business strategy with respect to territorial sales following the investment transaction is not clearly erroneous. Paramount.

Contribution Claims Should Be Subordinated to Claims of a Debtor’s General Unsecured Creditors

An issue on appeal concerned the Bankruptcy Code’s application to contribution/reimbursement claims for losses incurred while defending and settling securities fraud suits brought by investors in securities issued by a debtor’s affiliate. Appellants challenged an order subordinating their contribution claims to claims of a debtor’s general unsecured creditors. On December 14th, the Second Circuit held that such claims should be subordinated in the debtor’s bankruptcy proceeding to all claims or interests senior or equal to claims in the bankruptcy proceeding that are of the same type as the underlying securities. Lehman.

Exchange Act Calls for SEC Review of Allegations of Improper ‘Payment for Order Flow’ Fees

Securities firms and members of defendants’ national securities exchanges sued in state court to recover fees they claimed they were improperly charged under defendants’ payment for order flow (“PFOF”) programs. Defendants removed the case to federal court, which dismissed it for failure to exhaust administrative remedies. Plaintiffs argued that, as defendants acted outside of their regulatory function, there is no need for exhaustion of remedies before the SEC. The Seventh Circuit affirmed on December 11th, holding that the Exchange Act calls for SEC review of plaintiffs’ allegation of improper PFOF fees. SEC Review.

Industry News

SEC Approves Overstock.com’s Plan to Issue Shares on Bitcoin Blockchain

On December 17th, CFO.com reported that the SEC has approved online retailer Overstock.com’s plan to issue company shares on the Bitcoin blockchain. According to Bitcoin Magazine, “in traditional equity trades today, the markets operate on a trade date plus three days (T+3) settlement mechanism in which the exchange of payment and securities can take up to three days to settle … with the blockchain, it can be instantaneous and occur at the same time as the trade.” CFO.com Article.

Martin Shkreli, Who Infamously Raised the Price of a Life-Saving Drug, Is Charged with Securities Fraud

The Atlantic reported that Martin Shkreli, the drug company entrepreneur who infamously raised the price of a life-saving pill from $13.50 to $750, was arrested by federal agents on December 17th. Lawyer Evan Greebel, now a partner at Kaye Scholer, was arrested on the same day. Shkreli and Greebel were charged with two counts of securities fraud, three counts of conspiracy to commit securities fraud, and two counts of conspiracy to commit wire fraud. Bloomberg Business reported that Shkreli was charged with illegally taking stock from Retrophin Inc., a biotechnology firm that he started in 2011, and using it to pay off debts from unrelated business dealings. While at Katten Muchin Rosenman LLP, Greebel served as lead outside counsel to Retrophin from 2012 to 2014. Shkreli had been ejected from Retrophin and sued by its board “because of,” according to the company, “serious concerns about his conduct.” According to the indictment, Shkreli ran his companies like “a Ponzi scheme” and “lied to his investors.” The Atlantic Article.

Legislation Would Restrict the SEC from Requiring Disclosure of Corporate Political Contributions

On December 16th, The Wall Street Journal reported that congressional lawmakers have unveiled a provision that would restrict the SEC from forcing public companies to disclose their political activities. If signed into law, the provision would prevent the SEC from using funds authorized by the bill to “finalize, issue, or implement” a rule on disclosure of political contributions, or contributions to trade associations and other tax-exempt organizations. Political Contributions.

Complicated Derivatives, Popular Overseas, Are Used by Scammers to Earn Money Based on Inside Information

On December 16th, Bloomberg Business reported on the increasing concern of U.S. regulators about a complicated derivative that is popular overseas and was used by scammers to earn millions of dollars based on inside information. The derivatives, which are called contracts for differences (“CFDs”), are banned in the U.S. and have proven difficult for regulators to track since they do not trade on exchanges. CFDs are legal in the U.K. and becoming more common there, with the number of people who trade CFDs increasing by 14 percent to 24,000 in 2014 from a year earlier. This is motivating the SEC to focus more on investigating CFDs since they often involve trading of U.S. stocks. CFDs.

Fast-Money Shadow-Bank Financing Is on the Rise

On December 15th, Bloomberg Business reported that Scott Peng, the head of global portfolio solutions at Secor Asset Management and the strategist who first warned about banks’ misstating key benchmark lending rates during the 2008 financial crisis, is now warning that the money that finances the U.S. economy is now coming from shadow banks. In an interview, Peng noted that “since 2008, we’ve reformed the banking system by ring-fencing our banks with more regulatory and capital requirements … but our economy is now much more dependent on the fast-money shadow-bank financing – which is more fickle in terms of extending credit and can expand or contract much quicker.” Shadow Banking.

Two Federal Appeals Court Decisions Could Make it Harder for the Justice Department and the SEC to Pursue Securities Fraud Actions

On December 14th, Dealbook reported on two recent federal appeals court decisions, United States v. Litvak and Flannery v. Securities & Exchange Commission, that could make it harder for the Justice Department and the SEC to pursue cases because these decisions give more leverage to defendants to be able to claim that there is not enough evidence to prove the materiality of their alleged misstatements. Dealbook noted that these decisions could have a significant impact because they validate the use of experts to testify that even if there were misrepresentations, they were immaterial to sophisticated investors. As a result, these decisions can possibly make future securities fraud charges involving sophisticated parties more difficult to prove by bolstering the argument that the type of client receiving the information can be critical to determining whether any misstatements were actually material. Dealbook.

Regulation Crowdfunding Could Be Held Back by Three Policy Issues

On December 14th Crowdfund Insider reported that while the SEC’s new rules implementing Title III of the JOBS Act will come into effect on May 16, 2016 under which the SEC made some improvements over the proposed rules that will make Regulation Crowdfunding more accessible for small issuers, there are three areas where issuers would benefit if the SEC or Congress revisits its regulatory and statutory language. First, commenters have requested that the SEC allow single purpose funds when investing in issuers conducting offerings under Section 4(a)(6) of the Securities Act. Second, a “testing the waters” provision would allow issuers to determine whether it makes sense to move forward with raising capital, as initiating an offering under Regulation Crowdfunding will be a gamble for any issuer. Finally, as to conditional exemption from Exchange Act reporting, companies may opt to engage a broker that would hold the securities for the benefit of the investors and provide important services to the issuing company and investors by ensuring records are kept correctly and facilitating communication between the issuer and the investors. Regulation Crowdfunding.