Insights from Winston & Strawn

Federal Reserve Gives Indications on Capital Standards for Insurance Companies

Last Friday, in a speech to the National Association of Insurance Commissioners, Daniel Tarullo, one of the Governors of the Federal Reserve Board of Governors (“Federal Reserve”), gave a speech outlining capital standards that the Federal Reserve may soon make applicable to certain U.S. insurers.  Following passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), the Federal Reserve gained regulatory authority over insurers that either (i) own depository institutions, or (ii) are considered so large as to be designated as “systemically important financial institution” (“SIFI”) by the Financial Stability Oversight Council.

The Federal Reserve is considering a two-tiered approach to capital standards, with the more demanding of te two standard only being applied to SIFIs.  The lower tier—what Tarullo termed the “Building Block Approach”—would be applicable to any insurer that owns a depository institution and would “aggregate capital resources and capital requirements across the different legal entities …. A firm’s aggregate capital requirements generally would be the sum of the capital requirements at each subsidiary … [and] generally would be based on the regulatory capital rules of that subsidiary’s lead regulator whether a state or foreign insurance regulator or a federal banking regulator for depository institutions.”  The Federal Reserve has recognized that significant harmonization will be required to implement this standard, including variations in accounting standards, allowing for international considerations, tracking interaffiliate transactions, and “develop[ing] a formula or scalar" to make capital standards of the various regulators more comparable.

The second tier, what Governor Tarullo called the “Consolidated Approach,” is similar to the approach that the Federal Reserve takes with capital requirements for bank holding companies (“BHCs”).  This approach “would categorize all of the consolidated insurance group’s assets and insurance liabilities into risk segments, apply risk factors to the amounts in each segment, and then set a minimum ratio of required capital comparing the consolidated capital requirements to the group’s consolidated capital resources.” The major difference between the approach proposed for insurance companies and the approach in place for BHCs—and a sign that the Federal Reserve is at least trying to account for the significantly different nature of the insurance and banking industries—is  that, for insurance companies, the Federal Reserve would “use risk weights or risk factors that are more appropriate for the longer-term nature of most insurance liabilities.”

Governor Tarullo also stated that, particularly in the case of firms considered systemically important and in keeping with the imposition of enhanced prudential standards, the Federal Reserve would be imposing stricter rules in the areas of corporate governance, risk management, and liquidity.

The proposed rules are expected “in the coming weeks.”  Please contact your normal Winston and Strawn attorney after the proposed rules are published if you would like guidance or assistance on commenting on the proposal.

Feature: Shadow Banking Developments

In their efforts to maintain financial stability, regulators across the globe continue to target shadow banking. On May 3rd, the Federal Reserve issued a notice of proposed rulemaking  that would impose new restrictions on the terms of non-cleared qualified financial contracts (“QFCs”) to enhance the resolvability of U.S. global systemically important banking institutions (“GSIBs”) and the U.S. operations of foreign GSIBs. Under the proposal, a GSIB would be required to amend its QFCs, which are used for derivatives, securities lending, and short-term funding transactions, to prevent their immediate cancellation in the event the GSIB enters bankruptcy. The proposed rules would also require QFCs to restrict the ability of counterparties to terminate the contract, liquidate collateral, or exercise other default rights based on the resolution of a GSIB’s affiliate. GSIBs would be able to comply with the rules by using QFCs modified by the International Swaps and Derivatives Association’s (“ISDA”) 2015 Resolution Stay Protocol. The Federal Reserve will accept comments on the proposal through August 5, 2016.Federal Reserve Press Release.

The Federal Reserve proposed the rules to address concerns that the mass cancellation of QFCs might disrupt the resolution process of a GSIB, trigger asset fire sales, and spread financial risk across the U.S. financial system. Jeremy R. Newell, writing for American Banker, applauded the proposal for addressing risks to financial stability posed by the shadow banking system, maintaining that “enduring improvements to the resilience of our financial system must reflect all of that system, including the parts that lie outside the banking perimeter.”  Newell also noted that some parts of the shadow banking system have raised concerns that the proposal will “reshape how they trade derivatives” and interfere with their “contractual rights.”

Growing fears about financial stability are prompting Chinese regulators to curb the growth of shadow banking and rein in banks’ relationships with shadow lenders.   On May 18th, Reuters reported that Chinese regulators are drafting rules that would establish thresholds for mutual funds seeking to set up subsidiaries and would require those subsidiaries to meet capital ratios in an effort to limit their ability to expand. The article notes that mutual fund subsidiaries have expanded rapidly over the last year and are a “key channel for shadow banking activities” in China. News of the draft rules follows on the heels of reports earlier this month that China is taking additional measures to limit banks’ ability to mask bad loans and other debt through obscure shadow banking products. The Wall Street Journal reported that China’s banking regulator issued a directive to commercial banks that asks the banks to stop using funds from their own financial products to invest in credit beneficiary rights, a product in which a bank retains a loan or trust but transfers the right to a stream of income from the underlying asset to a buyer and often involves shadow banks as the deals become more complex. The transaction allows the bank to record the underlying loan as an investment receivable and avoid higher capital requirements as a result. According to a report in Bloomberg, China recently introduced new rules that will require banks to provide for the loan rights they transfer to other banks, which will require banks to raise additional capital to account for their shadow banking exposures.

European regulators are also focused on developing a framework to introduce additional transparency into shadow banking activities. Earlier this spring, the European Securities and Markets Authority (“ESMA”) published a Discussion Paper that proposes the reporting framework for the Securities Financing Transaction Regulation, which will require both financial and non-financial market participants to report the details of their securities financing transactions. ESMA’s Discussion Paper sets out the fields for the proposed data to be reported, including information about the composition of collateral and whether the collateral is available for use or has been reused. The Discussion Paper also proposes the registration requirements for Trade Repositories that will accept reports on security financing transactions. ESMA expects to develop rules based on the feedback it receives to the Discussion Paper and will publish a follow-up consultation later this year.

While it remains to be seen whether the latest measures by regulators will be effective at curbing the risks to financial stability posed the shadow banking sector, a new report by analysts at the Federal Reserve Bank of New York suggests that some regulatory efforts have resulted in unintended consequences. Sooji Kim, Matthew Plosser, and João Santos recently examined the effectiveness of interagency guidance issued by four federal financial regulators in March 2013. The agencies designed the guidance to encourage all supervised financial institutions to limit leveraged lending. While the largest financial institutions did limit their leveraged lending activities in response to the guidance, the reduction in leveraged lending by supervised banks “did not necessarily result in an equivalent risk reduction.” As an article in Bloomberg explains, while supervised banks may have stopped their leveraged lending activities, the financial institutions increased their lending to shadow banks that, in turn, used those funds to finance their own lending to risky companies.

Banking Agency Developments


OCC to Host Risk Governance and Credit Workshops in Milwaukee

On May 19th, the Office of the Comptroller of the Currency (“OCC”) announced that it will host two workshops in Milwaukee at the Crowne Plaza Milwaukee Airport, June 28-29, for directors of national community banks and federal savings associations supervised by the OCC. The Risk Governance workshop on June 28th will combine lectures, discussion, and exercises to provide practical information for directors to effectively measure and manage risks. The Credit Risk workshop on June 29th will focus on credit risk within the loan portfolio, such as identifying trends and recognizing problems.

Bulletin Addresses Compliance With SEC Money Market Fund Rules by Bank Fiduciaries, Deposit Sweep Arrangements, and Bank Investments

On May 19th, the OCC issued a bulletin to highlight actions that national banks and federal savings associations should take and factors that banks should consider based on the Securities and Exchange Commion's ("SEC") revised money market fund rules in effect now and going into effect in the near future.

‘Interagency Guidance Regarding Deposit Reconciliation Practices’ Is Issued.

On May 18th, the OCC, along with the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau (“CFPB”), the Federal Deposit Insurance Corporation (“FDIC”), and the National Credit Union Administration (“NCUA”) announced the issuance of the “Interagency Guidance Regarding Deposit Reconciliation Practices” to make financial institutions aware of the supervisory expectations regarding deposit reconciliation practices for customer accounts.

OCC Names New Deputy Comptroller for Public Affairs

On May 16th, the OCC announced that it had selected Bryan Hubbard as Deputy Comptroller for Public Affairs. Mr. Hubbard succeeds Robert M. Garsson, who is retiring on May 31st. OCC Press Release.

Registration Is Open for Forum on ‘Supporting Responsible Innovation in the Federal Banking System.’

On May 16th, the OCC opened registration for its forum on “Supporting Responsible Innovation in the Federal Banking System.” The OCC will host the forum on June 23, 2016 at its headquarters in Washington D.C. A variety of panelists will discuss trends in financial innovation, managing risks associated with innovation, incorporating innovation into strategic plans, and innovation’s potential to promote financial inclusion and consumer protection. OCC panelists will cover the agency’s perspective on financial innovation as well as comments it has received regarding its white paper, Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective,” which was published in March. OCC Press Release.


FDIC Advisory Committee on Economic Inclusion to Meet

On May 20th, the FDIC announced that its Advisory Committee on Economic Inclusion will meet on Wednesday, May 25th, to discuss the Mobile Financial Services Report.

Six Federal Agencies Invite Public Comment on Proposed Rule to Prohibit Incentive-Based Pay

On May 16th, six federal agencies (the FDIC, the Federal Housing Finance Agency (“FHFA”), the Federal Reserve, the NCUA, the OCC, and the SEC) announced that they are inviting public comment on a proposed rule to prohibit incentive-based compensation arrangements that encourage inappropriate risks at covered financial institutions. The deadline for comments on the proposed rule, which was submitted for publication in the Federal Register, is July 22, 2016. FDIC Press Release.

Winston hosted a webinar on the proposed rule on May 19.  The presentation and audio recording are available here.

Treasury Department Developments


FinCEN Deputy Director Delivers Speech on Anti-Money Laundering

On May 16th, Jamal El-Hindi, Deputy Director, Financial Crimes Enforcement Network (“FinCEN”) spoke at the Institute of International Bankers Annual Anti-Money Laundering Seminar about the rulemaking process.

Securities and Exchange Commission


Division of Corporation and Finance Publishes Updated Interpretation on Non-GAAP Financial Measures

The’s SEC’s Division of Corporation and Finance updated its Compliance and Disclosure Interpretations (“C&DIs”) on non-GAAP financial measures. Among other things, the updated C&DIs address conditions that may cause a non-GAAP measure to be misleading, provides examples of disclosures that would cause a non-GAAP measure to be more prominent than its most directly comparable GAAP measure, and explains how to reconcile earnings before interest and taxes (“EBIT”) or earnings before interest, taxes, depreciation and amortization (“EBITDA”) to the appropriate GAAP financial measure. Non-GAAP Financial Measures C&DIs.

New Interpretations Offer Guidance on Regulation Crowdfunding

The SEC’s Division of Corporation Finance published new C&DIs on May 13th that address several questions related to Regulation Crowdfunding. The C&DIs provide additional information about crowdfunding exemption and requirements, including the information issuers can disseminate prior to filing Form C; disclosure requirements for recently formed issuers; restrictions on advertising the “terms of the offering” under Rule 204; and the application of the rule’s advertising restrictions to third parties compensated by the issuer to promote the offering. Regulation Crowdfunding C&DIs.

SEC Publishes Small Entity Compliance Guide for Issuers under Regulation Crowdfunding

The SEC released a new small entity compliance guide on May 13th that offers guidance to companies issuing securities under the Regulation Crowdfunding exemption. The guide provides an overview of the rules as they apply to issuers, with an emphasis on disclosure requirements, limitations on advertising, and promotion and resale restrictions. The guide also provides links to the adopting release and other resources. SEC Small Entity Compliance Guide.

Division of Trading and Markets Offers Guidance to Crowdfunding Intermediaries

On May 13th, the SEC’s Division of Trading and Markets published a new small entity compliance guide on Regulation Crowdfunding directed at crowdfunding intermediaries, including registered broker-dealers and funding portals.  The guide summarizes and explains the substantive requirements for crowdfunding intermediaries, including registration, disclosure, and due diligence requirements; prohibited activities; the safe harbor for certain funding portal activities; and disqualification rules for intermediaries. SEC Small Entity Compliance Guide.

Speeches and Statements

SEC Chair White Says ETFs Could Be Subject to Additional Regulations

The Wall Street Journal summarized SEC Chair Mary Jo White’s keynote address to the Investment Company Institute’s general membership meeting on May 20th. In her remarks, White said that the SEC is closely examining the operations of exchange-traded funds (“ETFs”), especially the arbitrage activity of Wall Street dealers, to determine if regulatory measures aside from additional disclosures are necessary to avoid trading disruptions related to ETFs. Chair White also indicated that the SEC is considering improvements to mutual fund disclosures.  White Remarks.

SEC Will Keep a Close Watch on JOBS Act Capital Formation Methods

In opening remarks to the SEC Advisory Committee on Small and Emerging Companies meeting on May 18th, SEC Chair White reviewed recent developments related to capital formation for small and emerging companies, including the launch of Regulation Crowdfunding and the SEC’s concept release on the financial disclosure requirements under Regulation S-K. Chair White indicated that the SEC will closely monitor how markets develop under Regulation Crowdfunding and other new capital-raising methods created by the JOBS Act. White Remarks.

SEC and Treasury Department Collaborate on Plan for Trade Reporting in U.S. Treasury Market

In a joint statement released on May 16th, the SEC and the U.S. Department of the Treasury announced that they are exploring efficient and effective ways to gather U.S. Treasury cash market transaction information. The agencies will ask the Financial Industry Regulatory Authority (“FINRA”) to consider a proposal to require its member brokers and dealers to report Treasury cash market transactions to a centralized repository. The Treasury Department also indicated that it will continue to work with other agencies to create a plan to collect similar information from non-FINRA members who actively trade U.S. Treasury securities. SEC Press Release.

Other Developments

Investor Advisory Committee Will Hold Telephonic Meeting.

On May 19th, the SEC announced that a telephonic meeting of its Investor Advisory Committee will be held on June 7, 2016, to discuss the SEC’s concept release on business and financial disclosures under Regulation S-K and a recommendation of its Market Structure subcommittee to enhance information for bond market investors. Written statements should be submitted on or before June 7, 2016. SEC Release No. 33-10079.

SEC Publishes Technical Corrections to Final Rules on Business Conduct Standards for Security-Based Swap Dealers

The SEC published a corrected version of its final rules on business conduct standards for security-based swaps dealers and major security swap participants on May 19th. The revised final rules make technical corrections to a burden estimate for Paperwork Reduction Act purposes and a corresponding estimate in the Economic Analysis of the business conduct standards for security-based swap dealers and major security-based swap participants.SEC Release No. 34-77617a.

SEC Intends to Adjust Dollar Threshold Amounts for Performance-Based Investment Advisory Fees to Qualified Clients

The SEC provided notice on May 18th that it intends to issue an order that will make the inflation adjustment, as required by the Dodd-Frank Act, to the assets-under-management test and net worth test in the definition of “qualified client” pursuant to rules promulgated under the Investment Advisers Act of 1940 (“Advisers Act”) that permit investment advisers to charge performance-based fees to such clients. The order would maintain the dollar amount of the assets-under-management test at $1,000,000, and would increase the dollar amount of the net worth test from $2,000,000 to $2,100,000. Hearing requests should be received by the SEC by 5:30 p.m. on June 13, 2016. SEC Release No. IA-4388.

Whistleblower’s Detailed Tip Results in Award of Over $5 Million

The SEC will make its third highest whistleblower award to a company insider who provided detailed information about securities violations, according to an announcement by the SEC on May 17th. The whistleblower will receive between $5 million and $6 million for notifying the SEC about securities laws violations that would have otherwise been impossible for the SEC to detect. SEC Press Release.

SEC Awards Whistleblower $3.5 Million for Providing a Significant Tip During an Ongoing Investigation

On May 13th, the SEC announced that it awarded $3.5 million to a whistleblower who provided a tip that greatly enhanced the SEC’s ongoing investigation of misconduct at the whistleblower’s company. The SEC encouraged whistleblowers to report suspected misconduct to the SEC even if they believe the SEC is already investigating the matter, noting that this particular whistleblower’s tip came in the middle of its investigation but significantly strengthened the SEC’s case. SEC Press Release.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Financial Industry Regulatory Authority

FINRA Proposes Changes to Arbitration Procedures for Handling Monetary Awards

On May 17th, the SEC requested comments on a proposed rule change filed by FINRA that would amend its rules on arbitration procedures for industry and customer disputes to provide that when arbitrators order opposing parties to pay each other damages, the monetary awards shall offset, and the party that owes the larger amount shall pay the net difference, unless an award makes a specification to the contrary. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of May 23, 2016.SEC Release No. 34-77844.

FINRA Prepares Firms for New Rules on Recruitment Practices

In a Regulatory Notice published on May 16thFINRA reviewed new rules on firm recruitment practices and account transfers. Under the new rules, which will become effective on November 11, 2016, firms that recruit registered representatives will be required to inform the representatives’ former customers about the potential implications of transferring their assets to the recruiting firm. FINRA will prepare an educational communication that firms may provide to these customers in either paper or electronic form. FINRA Regulatory Notice 16-18.

Fixed Income Clearing Corporation

FICC Proposes to Suspend the Interbank Service of its General Collateral Repo Trading Service

On May 16th, the SEC provided notice of a proposed rule change filed by the Fixed Income Clearing Corporation (“FICC”) that would suspend the interbank service of the GCF Repo service, which permits participants to trade general collateral repos throughout the day without requiring intra-day, trade-for-trade settlement on a delivery-versus payment basis.  FICC has proposed the change to comply with recommendations by the Tri-Party Repo Infrastructure Reform Task Force. Comments should be submitted on or before June 10, 2016. SEC Release No. 34-77840.


NASDAQ Withdraws Proposed Changes to Processing of Pegging Attribute Orders on the Opening Cross

On May 13th, the SEC provided notice that the NASDAQ Stock Market LLC (“NASDAQ”) has withdrawn its proposed rule change to modify the processing of certain orders that are eligible to participate in the Opening Cross and have a Pegging Attribute or are designated for routing. SEC Release No. 34-77831.


NYSE Warns Members about Disruptive Trading Activity

On May 19th, the New York Stock Exchange LLC (“NYSE”) issued an Information Memo reminding members of their obligations to avoid engaging in trading or quoting activity that disrupts the trading of securities on NYSE Exchanges. The Information Memo identifies several factors that the NYSE will consider when determining whether or not trading constitutes disruptive activity and discusses certain situations that can constitute disruptive activity, including non-bona fide trading, other manipulative activity, and non-manipulative activity. NYSE Information Memo 16-06.

SEC Seeks Comments on NYSE’s Amended Proposed Listing Standards for Equity Investment Tracking Stocks

On May 17th, the SEC requested comments on NYSE’s recently filed amendment to its proposal to adopt initial and continued listing standards for the listing of Equity Investment Tracking Stocks and to adopt listing fees specific to Equity Investment Tracking Stocks that are the sole listed common equity security of the issuer. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of May 23, 2016. SEC Release No. 34-77850.

SEC Takes More Time to Consider NYSE’s Proposed Amendments to Pre-Opening Indications and Opening Procedures

On May 13th, the SEC designated July 5, 2016, as the date by which it will approve, disapprove, or institute disapproval proceedings regarding NYSE’s proposal to amend its rules relating to pre-opening indications and opening procedures. SEC Release No. 34-77829.

Judicial Developments

Investors’ 2013 Actions Against Funds Are Barred by Statutes of Repose

Investors filed actions in 2013 pursuant to the Securities Act of 1933 (“Securities Act”), the Securities Exchange Act of 1934 (“Exchange Act”), and SEC Rule 10b-5, asserting claims with repose periods of three and five years. The investors alleged they suffered substantial investment losses because defendant funds were overvalued and heavily concentrated in certain types of risky securities. The district court dismissed their actions as barred by the applicable statutes of limitations. The Sixth Circuit affirmed on May 19th, agreeing that the actions were untimely but holding that they were barred by the applicable statutes of repose. Stein.

Materially Identical Extender Statute for FDIC Action Displaces Securities Act’s Statute of Repose

The FDIC brought an action, which asserted claims under the Securities Act, within the limitations period provided by the FDIC Extender Statute but outside the Securities Act’s three‐year statute of repose. A district court dismissed the FDIC’s complaint as untimely. The Second Circuit held that the FDIC’s complaint was timely. The panel vacated and remanded on May 19th, citing Federal Housing Finance Agency v. UBS Americas Inc., in which it held that a materially identical extender statute for actions brought by the FHFA did displace the Securities Act’s statute of repose. FDIC.

U.S. Supreme Court Unanimously Holds That Federal Securities Laws Do Not Limit State Lawsuits.

A shareholder contended he lost most of his investment in Escala Group. Inc., (“Escala”) when the share price tumbled after petitioners devalued Escala through “naked short sales” of their stock. The shareholder brought suit in New Jersey state court but the petitioners removed the suit to federal court pursuant to Section 27 of the Exchange Act. On May 16th, the U.S. Supreme Court remanded back to state court, unanimously holding that the Exchange Act does not block the shareholders from bringing their claims in state court under the state’s securities and anti-racketeering laws. Escala.

Industry News

Merely Naming Golf Pro as a ‘Relief Defendant’ in Insider Trading Case Could Indicate the Changing Landscape of Insider Trading Law

On May 19th, Bloomberg suggested that merely naming pro golfer Phil Mickelson as a “relief defendant” in the insider trading case against a sports gambler and a former Dean Foods chairman may be a reflection of the shift of the legal landscape around insider trading law following the U.S. Court of Appeals for the Second Circuit’sUnited States v. Newman, which set new limits on insider trading prosecutions. Bloomberg.

Nasdaq Threatens Lawsuit Against SEC if it Approves IEX Group Inc.’s Exchange

On May 19th, the Wall Street Journal reported that Nasdaq Inc. warned that the SEC could be sued if it approves the IEX Group Inc.’s bid to become a full-fledged stock exchange. Nasdaq noted that the SEC would be violating its own rules by approving the exchange, which includes a speed bump that slows incoming orders by 350 microseconds. The Wall Street Journal.

Senate Banking Committee Approves Nominees for Two SEC Spots

On May 19th, Reuters reported that the U.S. Senate Banking Committee has approved nominees for the two vacant spots on the five-member SEC. The nominations of Democrat Lisa Fairfax and Republican Hester Peirce now go to the full Senate. Reuters.

SEC Chair Says That Cybersecurity Is the Biggest Treat Facing Financial Systems Worldwide

SEC Chair White said at the Reuters Financial Regulation Summit on May 17th that the biggest threat facing financial systems both in the U.S. and abroad is cybersecurity. On May 18th, Fortune reported on Chair White’s comments that, while major stock exchanges, clearing houses, and other financial entities tend to be aware of the risks they face, they generally have “policies and procedures (that) are not tailored to their particular risks.”Fortune.

Activist Investor Presses Music-Streaming Service to Consider Putting Itself Up For Sale

On May 17th, Forbes reported that activist investor Keith Meister is calling for a music-streaming service, whose shares have gone down 41% over the last year, to put itself up for sale. Meister, who is the managing partner of Corvex Management and the music company’s largest shareholder through Corvex, sent a letter to the music company’s board stating that he and his team have “become increasingly concerned that the company may be pursuing a costly and uncertain business plan, without a thorough evaluation of all shareholder value-maximizing alternatives.” Forbes.

Securities-Based Crowdfunding Have Taken Effect.

On May 16th, CFO reported that Title III of the JOBS Act, or the “crowdfunding exemption,” has gone into effect. Prior to this exemption, only accredited investors were able to hold equity in small companies and start-up companies. CFO.