Insights from Winston & Strawn

SEC Announces Record-Breaking Enforcement Results for Fiscal Year 2016

The SEC announced on October 11th that it filed a record number of enforcement actions in fiscal year 2016. SEC Press Release. During the fiscal year, which ended September 30, 2016, the SEC filed 868 enforcement actions for financial reporting-related misconduct by companies and their executives, as well as misconduct by registrants and gatekeepers. This number represents a new single-year high for enforcement actions and led to judgments and orders totaling more than $4 billion in disgorgement and penalties.

The SEC’s enhanced use of data analytics contributed to this uptick in enforcement actions. According to SEC Chair Mary Jo White, “Over the last three years, we have changed the way we do business on the enforcement front by using new data analytics to uncover fraud, enhancing our ability to litigate tough cases, and expanding the playbook bringing novel and significant actions to better protect investors and our markets.” The use of data analytics has been particularly key for spotting suspicious trading and uncovering complex insider trading rings.

Market participants should also be aware of several first-of-their-kind actions brought in fiscal year 2016, including charges against: a brokerage firm, solely for failing to file Suspicious Activity Reports when appropriate; an audit firm, for auditor independence failures predicated on close personal relationships with audit clients; municipal advisors, for violating the fiduciary duty for municipal advisors created by the 2010 DoddFrank Act and the municipal advisor antifraud provisions of the Dodd-Frank Act; a private equity adviser, for acting as an unregistered broker; and an issuer of retail structured notes, for misstatements and omissions.

These new actions, along with the SEC’s emphasis on whistleblowing—its whistleblower program awarded more than $57 million to whistleblowers in fiscal year 2016, which is more than in all previous years combined —and its emphasis on holding gatekeepers, such as attorneys, accountants, fund administrators, and others accountable, show the SEC’s commitment to enforcement throughout the industry.

Feature: D.C. Circuit Finds Structure of CFPB is Unconstitutional

On October 11th, the U.S. Court of the Appeals for the D.C. Circuit issued its decision in PHH Corporation v. CFPB and delivered a blow to the authority of the Consumer Financial Protection Bureau (“CFPB”). In a highly anticipated and lengthy opinion, the panel held that the structure of the agency violates Article II of the Constitution because it lacks a critical check by concentrating its executive power in a single Director who can only be removed by the President for cause. The court, however, declined to shut down the CFPB’s operations entirely, opting instead to follow Supreme Court precedents and sever the for-cause provision from the Dodd-Frank Act, which will place the CFPB Director under the supervision and direction of the President.

Writing for the court, Circuit Judge Brett Kavanaugh said that the CFPB’s structure “represents a gross departure from settled historical practice” and poses a great risk of “arbitrary decisionmaking and abuse of power.” Kavanaugh noted that other independent agencies, such as the Securities and Exchange Commission (“SEC”), are governed by multiple commissioners or board members to serve as a “substitute check” in the absence of Presidential oversight.

Congressional Republicans, including House Financial Services Committee Chair Jeb Hensarling, and others critical of the CFPB cheered the court’s ruling as an important step in limiting the agency’s powers. Consumer groups raised concerns that the ruling removed a critical protection to the agency’s independence and might introduce political considerations into its decisionmaking. Senator Elizabeth Warren downplayed the ruling, calling it a “small, technical tweak to Dodd-Frank.” Cornell Law School professor Robert Hockett told the Los Angeles Times that the ruling’s impact was “virtually without significance” to the agency’s day-to-day work of protecting consumers and may make the CFPB “even more zealous” in its investigations in response to a perceived “backlash against financial regulation.” The CFPB said that it is “considering its options” in light of the court’s ruling and will decide whether to request an en banc review of the decision or appeal directly to the Supreme Court.

The intense interest sparked by the court’s ruling on the constitutional question nearly overshadowed the court’s other decision: to grant review of the CFPB’s $109 million order against PHH Corporation for violations of the Real Estate Settlement Procedures Act (“RESPA”) in its use of captive reinsurance arrangements. The court held that Section 8 of RESPA allows captive reinsurance arrangements, in which a mortgage insurer buys reinsurance from a mortgage reinsurer affiliated with a referring mortgage lender, as long as the amount paid by the mortgage insurer for the reinsurance does not exceed the reasonable market value. The court found that the CFPB erred in its interpretation of RESPA, which was a departure from previous interpretations issued by the Department of Housing and Urban Development, and violated PHH’s due process rights by retroactively applying its new interpretation against PHH. The court also rejected the CFPB’s claim that there is no statute of limitations for CFPB administrative actions to enforce Section 8 of RESPA, finding that Dodd-Frank incorporated the underlying three-year statute of limitations under RESPA.

Upon remand, the court directed the CFPB to consider whether the relevant mortgage insurers paid more than reasonable market value for reinsurance to PHH-affiliated reinsurers under the captive reinsurance arrangements and whether PHH’s conduct occurred outside of the three-year statute of limitations.

Banking Agency Developments


OCC to Host Compliance and Operational Risk Workshops in Arkansas

On October 7th, the OCC announced that it will host two workshops in Little Rock, Ark., at the Wyndham Riverfront Little Rock, Nov. 15-16, for directors of national community banks and federal savings associations supervised by the OCC. The Compliance Risk workshop on Nov. 15th will combine lectures, discussion, and exercises on the critical elements of an effective compliance risk management program and will focus on major compliance risks and critical regulations. The Operational Risk workshop on Nov. 16th will focus on the key components of operational risk: people, processes and systems and will also cover governance, third-party risk, vendor management and cybersecurity. This is the final Operational Risk workshop for 2016.

Treasury Department Developments

Treasury Announces Final Earnings Stripping Regulations (Tax Inversions)

On October 13th, the U.S. Department of Treasury and the IRS announced that they have issued final regulations to address earnings stripping. This action will further reduce the benefits of corporate tax inversions, level the playing field between U.S. and non-U.S. businesses, and limit the ability of companies to lower their tax bills through transactions involving debt that do not support new investment in the U.S. These regulations also require large corporations claiming interest deductions to document loans to and from their affiliates, as businesses of all sizes do when they borrow from unrelated lenders. See Fact Sheet and Remarks by Treasury Secretary Lew.

Treasury and Federal Reserve Support Adoption of the G-7 Fundamental Elements of Cybersecurity for the Financial Sector

On October 11th, the Treasury and the Board of Governors of the Federal Reserve System announced the publication of the Group of 7 (G-7) Fundamental Elements of Cybersecurity for the Financial Sector. The finance ministers and central bank governors of the G-7 countries released the fundamental elements, which provide a concise set of principles on best practices in cybersecurity for public and private entities in the financial sector.

Securities and Exchange Commission

Final Rules

SEC Approves Rules to Modernize Information Reported by Funds

At an Open Meeting on October 13th, the SEC voted to adopt final rules to modernize the reporting and disclosure of information by registered investment companies, including mutual funds and exchange-traded funds (“ETFs”).  Among other things, the final rules will require registered funds to report monthly portfolio-wide and position-level holdings data on new Form N-PORT; report certain census-type information on new Form N-CEN on an annual basis; use a structured data format to report portfolio and census information; include additional, standardized disclosures in financial statements that are required in fund registration statements and shareholder reports; and make disclosures regarding securities lending activities in their fund registration statements. The final rules will become effective 60 days after publication in the Federal Register.  Most funds will be required to begin filing reports on new Forms N-PORT and N-CEN after June 1, 2018, while fund complexes with less than a $1 billion in net assets will be required to begin filing reports on Form N-PORT after June 1, 2019. SEC Press Release. SEC Commissioner Michael S. Piwowar dissented because the final rules omitted what he considered to be a “key component of the proposal” that would have allowed for the delivery of fund shareholder reports via investment companies’ websites. See also supporting statements by SEC Chair Mary Jo White and SEC Commissioner Kara M. Stein.

SEC Adopts Rules That Require Funds to Establish Liquidity Risk Management Programs

The SEC approved final rules on October 13th that will require mutual funds and other open-end management investment companies, including ETFs, to establish liquidity risk management programs. Under the rules, funds will have to assess, manage and periodically review their liquidity risk; classify each of the investments in their portfolios into one of four liquidity categories; determine a minimum percentage of their net assets that must be invested in highly liquid investments; and gain approval of their liquidity risk management programs by their boards, including a majority of independent directors. A fund would also be required to limit its purchases of illiquid investments if more than 15 percent of its net assets are illiquid assets.  The final rules will become effective 60 days after publication in the Federal Register. Most funds will be required to comply with the liquidity risk management program requirements on Dec. 1, 2018, while fund complexes with less than a $1 billion in net assets will be required to do so on June 1, 2019. SEC Press Release.  SEC Commissioner Kara M. Stein calledthe rule “a significant improvement to current requirements.”

SEC Approves Use of Swing Pricing by Certain Investment Companies

The SEC voted on October 13th to approve amendments to rule 22c-1 under the Investment Company Act to permit a registered open-end management investment company, except a money market fund or exchange-traded fund, to use “swing pricing,” which is the process of adjusting the fund’s net asset value (“NAV”) per share to effectively pass on the costs stemming from shareholder purchase or redemption activity to the shareholders associated with that activity. The amended rules would require funds that elect to use swing pricing to adjust their NAV by a specified amount, or the swing factor, once the level of net purchases into or net redemptions from the fund has exceeded the swing threshold, a specified percentage or percentages of the fund’s NAV. The fund’s board would also be required to approve its swing pricing policies and procedures. The final rules will become effective two years after publication in the Federal Register. SEC Press Release. Commissioner Piwowar votedagainst the rule amendments, citing “several investor protection concerns” including a concern that funds could use swing pricing “to conceal from investors the true costs they will incur upon the purchase and sale of their fund shares.”

Speeches and Statements

Ceresney Touts Success of SEC’s Public Finance Enforcement Actions

In a keynote address at the Securities Enforcement Forum 2016 on October 13th , SEC Division of Enforcement Director Andrew J. Ceresney discussed the SEC’s enforcement efforts in the municipal securities market and public pension funds. Ceresney maintained that the SEC’s focus on misconduct in the public finance area has “raised awareness among market participants about their obligations under the securities laws” and indicated that the SEC will continue to emphasize enforcement activity in this area. Ceresney Remarks.

SEC Not Likely to Consider Rule on Funds’ Use of Derivatives This Year, Says Piwowar

Reuters reported on SEC Commissioner Michael S. Piwowar’s remarks at Georgetown University on October 12th, in which he indicated that the SEC probably will not vote on final rules this year to restrict the use of derivatives by fund managers and require transition planning to minimize disruptions. Piwowar said that he did not support releasing the proposal on derivatives until the SEC gathers additional data to study the issue.  

Other Developments

EDGAR Updates

On October 14th, the SEC released the EDGAR Form N-MFP2 XML Technical Specification (Version 1).

SEC Announces Record-Breaking Enforcement Results for Fiscal Year 2016

The SEC announced on October 11 that it filed a record number of enforcement actions in fiscal year 2016, including an increase in actions involving financial reporting-related misconduct, investment advisers, and FCPA violations. The SEC also said that it distributed a record amount of money to whistleblowers in a single year. SEC Press Release.

Commodity Futures Trading Commission

Federal Register Publishes Final Rule on Clearing Requirement Determination Under Section 2(h) of the CEA for Interest Rate Swaps

On October 14th, the Federal Register published the U.S. Commodity Futures Trading Commission’s (“CFTC”) final rule requiring that interest rate swaps denominated in certain currencies and having certain termination dates be submitted for clearing to a derivatives clearing organization (“DCO”) that is registered under the Commodity Exchange Act (“CEA”) or a DCO that has been exempted from registration under the CEA. The amended rule is effective December 13, 2016.

CFTC Approves Order Regarding Swap Dealer Registration De Minimis Exception

On October 13th, the CFTC announced that it approved an Order establishing December 31, 2018 as the swap dealer registration de minimis threshold phase-in termination date. CFTC Regulation 1.3(ggg)(4)(ii)(C)(1) provides that the agency may terminate the December 31, 2017 phase-in termination date and establish a new phase-in termination date by Order. With this approval, the de minimis threshold will remain at $8 billion until December 31, 2018 instead of changing to $3 billion on December 31, 2017. Absent further action by the CFTC, the phase-in period would terminate on December 31, 2018, at which time the de minimis threshold will be $3 billion. See Federal Register Notice. Also see Chairman Massad’s statement and the concurring statement of Commissioner Bowen.

CFTC Releases Rule Enforcement Review of the NYMEX and COMEX

On October 13th, the CFTC’s Division of Market Oversight (“DMO”) announced that it has issued the results of a rule enforcement review of the New York Mercantile Exchange (“NYMEX”) and the Commodity Exchange (“ COMEX”). The DMO found that NYMEX and COMEX have adequate market surveillance programs, subject to one recommendation regarding the exchanges’ program for monitoring exemptions from position limits. The DMO recommended that NYMEX and COMEX “consider implementing a formal review process by which they can verify that a market participant who has a position larger than a position limit is, in fact, making use of an exemption, consistent with the strategy described in their exemption application.”

CFTC Approves Proposed Rule on Application of Certain Swap Provisions of the CEA in Cross-Border Transactions

On October 11th, the CFTC announced that it voted unanimously to propose rules and interpretations addressing the application of certain swap provisions of the CEA and CFTC regulations to cross-border transactions. The proposal defines key terms for cross-border transactions and addresses the cross-border application of the registration thresholds and external business conduct standards for swap dealers and major swap participants. It further addresses whether and to what extent these thresholds and standards would apply to swap transactions that are arranged, negotiated, or executed using personnel located in the U.S. The comment period ends 60 days after publication of the proposal in the Federal Register. For more information, see the Fact Sheet and the Federal Register Notice. Also see Chairman Massad’s statement, the concurring statement of Commissioner Bowen,  and Commissioner Giancarlo’s statement.

Division of Market Oversight Extends No-Action Relief for Swap Execution Facilities from Certain “Block Trade” Requirements

On October 7th, the DMO announced that it has extended time-limited no-action relief to Swap Execution Facilities (“SEFs”) from certain requirements in the definition of “block trade” in CFTC Regulations. Subject to certain conditions, CFTC Staff Letter 16-74 extends time-limited relief to SEFs from the “occurs away” requirement under Section 43.2 until November 15, 2017, or the effective date of any CFTC action with respect to the issues discussed in the no-action letter.

Federal Rules Effective Dates

October 2016 – December 2016

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Exchanges and Self-Regulatory Organizations

Fixed Income Clearing Corporation

SEC Approves FICC’s Proposed Blackout Period Exposure Charge for GCF Repo Participants

On October 11th, the SEC approved a proposed rule change filed by the Fixed Income Clearing Corporation (“FICC”) that would amend the Government Securities Division (“GSD”) Rulebook to include a margin charge increase that is imposed on Netting Members that participate in the GCF Repo service, which allows participants to trade general collateral repurchase agreements based on rate, term and underlying product throughout the day, without requiring intraday, trade-for-trade settlement on a delivery-versus-payment basis. SEC Release No. 34-79077

Miami International Securities Exchange

SEC Approves MIAX’s Complex Order Rules

On October 7th, the SEC issued an order approving Miami International Securities Exchange, LLC’s (“MIAX”) proposal to adopt rules to govern the trading of complex orders. SEC Release No. 34-79072

Municipal Securities Rulemaking Board

MSRB Asks Market Stakeholders to Provide Input on Strategic Priorities

The Municipal Securities Rulemaking Board (“MSRB”) requested comments on its core activities and strategic goals. The MSRB is interested specifically in comments about the future development of its Electronic Municipal Market Access (“EMMA”) website as well as how the agency should prioritize its ongoing and future efforts. Comments should be submitted on or before November 11, 2016. MSRB Press Release


SEC Takes More Time to Consider Phlx’s Proposed Rule Amendments on Specialists and Registered Options Traders

On October 12th, the SEC designated November 29, 2016, as the date by which it will approve, disapprove, or institute disapproval proceedings regarding NASDAQ PHLX LLC’s (“Phlx”) proposed rule change to delete or amend rule language relating to specialists and Registered Options Traders. SEC Release No. 34-79087

Phlx Proposes to Make Certain FLEX Options Eligible for Strategy Caps

 On October 11th, the SEC requested comments on a proposed rule change filed by Phlx that would amend its pricing schedule to permit Multiply Listed FLEX options to be eligible for the Section II Strategy Caps, which generally apply to all strategy executions executed in standard option contracts on the same trading day in the same option class. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of October 17, 2016. SEC Release No. 34-79080


SEC Initiates Disapproval Proceedings on NYSE’s Proposal on Unlisted Trading Privileges and Listing Requirements for ETPs

On October 12th, the SEC instituted disapproval proceedings regarding the New York Stock Exchange LLC’s (“NYSE”) proposal to allow the exchange to trade pursuant to unlisted trading privileges (“UTP”) any NMS Stock listed on another national securities exchange; to establish listing and trading requirements for exchange-traded products (“ETPs”); and to adopt new equity trading rules relating to trading halts of securities traded pursuant to UTP on NYSE’s Pillar trading platform.  Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of October 17, 2016. Rebuttal comments are due within 35 days. SEC Release No. 34-79085

NYSE Arca Proposes Widened Price Collar Thresholds to Address Market Volatility

On October 7th, the SEC requested comments on a proposed rule change filed by NYSE Arca, Inc. (“NYSE Arca”) that would amend its rules to provide for widened price collar thresholds for the Core Open Auction on volatile trading days. Under the proposal, the price collar thresholds for the Core Open Auction on days with market-wide volatility would be set at 10% for all Auction-Eligible Securities, regardless of the Auction Reference Price. Comments should be submitted on or before November 4, 2016. SEC Release No. 34-79068

Options Clearing Corporation

SEC Approves OCC’s Changes to Its Escrow Deposit Program

On October 13th, the SEC approved the Options Clearing Corporation’s (“OCC”) proposed rule change to modify its escrow deposit program by requiring securities in the escrow deposit program to be held at the Depository Trust Company, giving OCC the right to direct DTC to deliver the securities included in a member specific deposit, third-party specific deposit or escrow deposit to OCC’s DTC participant account for the purpose of satisfying the obligations of a clearing member or reimbursing itself for losses incurred as a result of clearing member or custodian bank default, and clarifying clearing members’ rights to collateral in the escrow deposit program in the event of a customer default to the clearing member. The SEC also issued a notice of no objection to OCC’s advance notice of its intention to implement changes to its escrow deposit program. SEC Release No. 34-79094

Judicial Developments

CFPB’s Structure as an Independent Agency Headed by a Single Director is Unconstitutional

Petitioner mortgage lender, which was the subject of a CFPB enforcement action, argued that the CFPB’s status as an independent agency headed by a single Director violates the Constitution. On October 11th, the D.C. Circuit agreed that this structure is unconstitutional, as it focuses massive executive power in a single, unaccountable, unchecked Director who can only be removed by the President for cause. The panel severed the for-cause provision from Dodd-Frank and directed the CFPB to continue to operate and perform its responsibilities, but under the ultimate supervision and direction of the President. CFPB

Industry News

CFTC Preparing to Amend Source-Code Proposal

On October 13th, the Wall Street Journal reported that the CFTC is getting ready to modify controversial segments of a regulatory plan to prevent automated trading glitches from shaking up futures and derivatives markets. The CFTC is expected to amend the proposal that would give it access to the intricate computer code that drives high-frequency trading firms’ trading decisions. According to the report, this new approach falls short of the industry’s demands that the agency not have access to the computer code without a subpoena enforced through the federal court system.