Insights from Winston & Strawn

With the second quarter of 2016 coming to a close, investment advisers should consider certain mid-year compliance items.  A brief summary of certain such compliance items is provided below.

  • Quarterly transaction reports. Advisers should confirm that their Chief Compliance Officer or other compliance personnel will be receiving and reviewing the applicable quarterly transaction reports from the appropriate advisory personnel in accordance with the terms of the adviser’s code of ethics.
  • Quarterly Form PF filing for advisers to “large” hedge funds and “large” liquidity funds. “Large” hedge fund advisers (hedge fund advisers with more than $1.5 billion in private fund assets under management) and “large” liquidity fund advisers (liquidity fund advisers with at least $1 billion in combined money market and liquidity fund assets under management) should remember to submit their quarterly Form PF filings. For large hedge fund advisers, the Form PF filing is due within 45 days after the quarter end, and for large liquidity fund advisers, the Form PF filing is due within 15 days after the quarter end.
  • 13F, 13H, and 13D filings. Advisers that meet the definition of “institutional investment manager” are required to file Form 13Fs within 45 days of the end of each calendar quarter. Form 13H filings (which require disclosure of certain information by “large traders”) are typically annual filings but must be promptly amended following the end of any calendar quarter in which any of the information contained in a Form 13H filing becomes inaccurate for any reason. Similarly, an adviser is required to promptly file an amendment to its Schedule 13D if there are any material changes to their current filing.
  • Treasury International Capital and Bureau of Economic Analysis Forms. Certain investment advisers and private funds that have significant transactions with, investments in, or relationships with non-U.S. entities, are required to submit quarterly and/or monthly Treasury International Capital Forms and/or reports to the Bureau of Economic Analysis.
  • Other Typical Mid-year Practices. Advisers should continue any other practices typically conducted at this time of year – annual compliance reviews, quarterly notices, distributions to investors, etc.

The above list is not exhaustive and highlights just a few of the compliance obligations of advisers. For example, investment advisers that are also commodity pool operators may also have financial statement delivery and CFTC and/or NFA filing obligations. Please contact your Winston & Strawn attorney if you have any questions about your periodic compliance obligations.

Feature: SEC Approves IEX’s Application to Register as a National Securities Exchange

Late in the day on June 17th, the Securities and Exchange Commission (“SEC”) finally decided the fate of Investors’ Exchange LLC’s (“IEX”) bid to become a full-fledged stock exchange, issuing an order approving IEX’s application to register as a national securities exchange. The SEC’s decision comes after two extensions of time by the SEC to consider IEX’s proposal, five amendments by IEX to its original application, and nearly a year of public debate over IEX’s proposed trading system, which employs a “speed bump” of 350 microseconds in an effort to prevent high-frequency traders from gaining an unfair advantage over other traders. SEC Chair Mary Jo White and Commissioner Kara Stein voted to approve IEX’s application, while Commissioner Michael Piwowar supported approval but dissented from approving certain aspects of the application, including granting IEX a “protected quote,” which would require brokers to route orders to IEX instead of other national stock exchanges when IEX quotes the best price.

IEX’s speed bump has been widely criticized by some exchanges and other market participants who claim that the delay in orders created by the speed bump violates requirements under Regulation NMS that exchanges provide investors with the best available price when they submit orders to buy or sell shares. Critics also argue that approving IEX’s trading model would prompt other venues to adopt a similar model, creating a fragmented market with several exchanges quoting outdated prices. In approving IEX’s application, the SEC noted that market participants already experience very short lags in receiving updated quotations due to geographic and technological delays, concluding that “the introduction of a small intentional delay … will [not] impair market transparency.”

In an effort to bolster this position, the SEC also published a final interpretation of the definition of “automated quotation” under Rule 600(b)(3) of Regulation NMS, or the Order Protection Rule (the “Rule”). Under Regulation NMS, an automated quotation is one that, among other things, can be “immediately and automatically” executed against an incoming immediate-or-cancel order, in contrast to manual quotations that produce delays in responding to incoming orders. The Rule protects these automated quotations by requiring trading centers to honor them and not execute trades at inferior prices. The SEC determined, in light of IEX’s application and other technological advances in the market, that “immediate” under the Order Protection Rule of Regulation NMS does not preclude a de minimis intentional delay, which the SEC defined as a delay so short as to not impair fair and efficient access to an exchange’s quotations.

Alongside the SEC’s final interpretation of “automated quotation,” Division of Trading and Markets staff issued new guidance on the SEC’s interpretation to assist market participants in understanding the duration of a de minimis intentional delay. In the guidance, the staff noted that the SEC declined to offer a specific threshold for the maximum length of a delay that would be permissible under its revised interpretation of “immediate.” The staff concluded that a delay of less than a millisecond is at a de minimis level that would not impair fair and efficient access to an exchange’s quotation, consistent with the purpose of Rule 611 of Regulation NMS. In reaching this conclusion, the staff noted that a one millisecond delay is within the geographic and technological latencies that market participants currently experience when routing orders between trading centers.

When issuing the revised interpretation of an “automated quotation,” the SEC indicated that it will continue to assess any potential impact on market quality created by intentional access delays and will ask staff to conduct a study and report its findings and recommendations to the agency within two years. According to a report in the Wall Street Journal, other exchanges may be preparing to emulate IEX’s speed bump model, noting that the New York Stock Exchange LLC (“NYSE”) has already proposed to copy another of IEX’s innovative features around pricing for certain hidden orders. The article also notes that clearing the SEC’s regulatory hurdles was only the first step for IEX, since it now faces the challenge of proving it can compete with larger exchanges.

Banking Agency Developments


Agencies Publish Notice of Proposed Rulemaking on Incentive-Based Compensation Arrangements

On June 23rd, the Office of the Comptroller of the Currency (“OCC”), jointly with the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (the “FDIC”), the National Credit Union Administration, the SEC, and the Federal Housing Finance Agency, announced publication of a notice of proposed rulemaking in the Federal Register to implement the incentive-based compensation provisions of Section 956 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd–Frank Act”). The proposal would establish new requirements for incentive-based compensation at certain covered institutions regulated by the agencies. Comments on the proposed rule are due July 22, 2016.

Comptroller Highlights Effort to Develop a Framework for Evaluating Responsible Innovation

On June 23rd, the OCC announced that Comptroller of the Currency Thomas J. Curry gave a speech at the agency’s Forum on Responsible Innovation about the OCC’s determination to develop a framework for identifying and evaluating responsible innovation.

Beverly F. Cole Named Deputy Comptroller for Compliance Supervision

On June 22nd, the OCC announced that Beverly F. Cole will become its Deputy Comptroller for Compliance Supervision. In this new role, Ms. Cole will serve as the operational executive responsible for developing and promulgating compliance operational protocols, examination strategies, and schedules. She will oversee a staff implementing bank supervision policy for compliance and establish programs to ensure efficient bank supervision for compliance. She will report to the Senior Deputy Comptroller for Compliance and Community Affairs and takes on these duties in July 2016.

Agencies Seek Comment on NSFR Proposed Rule

On June 21st, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC announced that they are seeking comment on a proposed rule that would strengthen the liquidity risk management of large banks and savings associations. The proposed net stable funding ratio (“NSFR”) rule would create a longer-term funding requirement designed to work in concert with the shorter-term liquidity coverage ratio (“LCR”) rule. While the LCR rule currently requires large banks and savings associations to hold sufficient high-quality liquid assets to survive a stress scenario lasting 30 days, the proposed NSFR rule would require these institutions to have sources of funding that are stable over a one-year period. The notice of proposed rulemaking was published in the Federal Register on June 1, 2016, and comments are due on August 5, 2016.

Federal Reserve

Federal Reserve Is Monitoring Developments in Global Financial Markets

On June 24th, the Federal Reserve announced that it is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the EU. The Federal Reserve noted that it is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.

Treasury Department Developments


FSOC Releases Sixth Annual Report

On June 21st, the Financial Stability Oversight Council (“FSOC”) announced the release of its 2016 annual report on issues including significant financial market and regulatory developments, potential emerging threats to the financial stability of the U.S., and FSOC activities. The report also makes recommendations to promote market discipline; maintain investor confidence; and enhance the integrity, efficiency, competitiveness, and stability of U.S. financial markets.

Securities and Exchange Commission


Division of Corporation Finance Offers Guidance on Rule 701’s Application to Derivative Securities Assumed during Merger Transactions

On June 23rd, the SEC’s Division of Corporation Finance updated its Compliance and Disclosure Interpretations (“C&DIs”) on Securities Act Rule 701, which provides an exemption for offers and sales of securities pursuant to certain compensatory benefit plans and contracts relating to compensation. The revised C&DIs contain new questions concerning the application of Rule 701 to the derivative securities of a target company assumed by the acquiring company during a merger transaction. C&DIs 271.17-217.23

Other Developments

Investor Advisory Committee to Hold Public Meeting

The SEC’s Investor Advisory Committee will meet on July 14, 2016, to discuss, among other things, investment company reporting modernization, the state of sustainability reporting, and the Electronic Communications Privacy Act amendments. Written statements should be submitted on or before July 14, 2016. SEC Release No. 33-10102

Divisions of Enforcement and Trading and Markets Launch Customer Protection Rule Initiative

On June 23rd, the SEC’s Divisions of Enforcement and Trading and Markets announced a new Customer Protection Rule Initiative (“CPR Initiative”) designed to address historical and ongoing violations of Section 15(c)(3) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 15c3-3 thereunder. Under the CPR Initiative, broker-dealers that have failed to comply with the Customer Protection Rule may self-report to both Divisions by November 1, 2016, and can expect favorable settlement terms if an enforcement action is warranted. The Divisions indicated that they will be conducting risk-based sweeps of certain broker-dealers, in coordination with the Office of Compliance Inspections and Examinations (“OCIE”), to assess their compliance with the Customer Protection Rule.

Division of Trading and Markets Releases Updated Money Market Fund Statistics

The SEC’s Division of Trading and Markets published updated Money Market Fund statistics on June 22nd. The updated statistics contain data as of May 31, 2016. Money Market Fund Statistics

Investor Advisory Committee Offers Comments on Regulation S-K Disclosure Modernization

On June 20th, the SEC released a letter from its Investor Advisory Committee containing the Committee’s comments regarding the SEC’s concept release on modernizing the business and financial disclosures under Regulation S-K. In the letter, the Committee identified several overarching principles that the SEC should consider as it contemplates changes to the current disclosure regime, including the audience for disclosure, the impact on retail investors, the degree to which proposed changes leverage technology, and the degree to which changes improve comparability and consistency. SEC Investor Advisory Committee Letter

Commodity Futures Trading Commission

Requests for Comment

CFTC Requests Public Comment on Requirement Submissions for Swap Clearing

On June 23rd, the Commodity Futures Trading Commission (“CFTC”) requested public comment on submissions the agency received over the past several years from seven registered derivatives clearing organizations pursuant to Section 2(h)(2)(B) of the Commodity Exchange Act and CFTC Regulation 39.5(b). The comment period will be open until July 25, 2016.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Financial Industry Regulatory Authority

FINRA Will Hold Elections for Its Board of Governors at Upcoming Annual Meeting

The Financial Industry Regulatory Authority (“FINRA”) announced on June 21st that it will hold elections for one Small Firm Governor and one Large Firm Governor to the FINRA Board of Governors at the upcoming annual meeting of FINRA firms, which will be held on or about September 19, 2016. Petitions for candidacy by eligible individuals should be submitted on or before August 5, 2016. FINRA Election Notice

ICE Clear

SEC Designates Longer Period to Consider ICC’s Proposed Changes to Its End-of-Day Price Discovery Policies

On June 23rd, the SEC designated August 9, 2016, as the date by which it will approve, disapprove, or institute disapproval proceedings regarding ICE Clear Credit LLC’s (“ICC”) proposed rule change relating to ICC’s End-of-Day Price Discovery Policies and Procedures. SEC Release No. 34-78144

International Swaps and Derivatives Association

ISDA Statement on U.K. Referendum Vote

On June 24th, the International Swaps and Derivatives Association (“ISDA”) issued a statement in response to the U.K. referendum vote to leave the European Union. In the statement, the ISDA notes that the vote will not immediately impact existing derivatives contracts or require immediate contractual action from counterparties. The ISDA plans to establish applicable working groups and hold a series of industry calls to address potential issues for derivatives market participants as a result of the vote. ISDA Statement

ISDA Responds to Basel Committee’s Proposals on Internal Risk Models

On June 22nd, the ISDA, along with the Global Financial Markets Association (“GFMA”), the International Association of Credit Portfolio Managers (“IACPM”) and the Japan Financial Markets Council (“JFMC”), published a response to the Basel Committee on Banking Supervision’s consultation on Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches. Among other things, the response raises concerns regarding the absence of risk sensitivity from the proposal, arguing that a lack of risk sensitivity would distort capital allocation decisions and pricing in a way that would hurt banks’ customers and the global economy. ISDA Press Release

Municipal Securities Rulemaking Board

MSRB Offers Access to ABLE Offering Documents on EMMA

The Municipal Securities Rulemaking Board (“MSRB”) announced on June 21rd that offering documents regarding securities established under the Stephen Beck Jr., Achieving a Better Life Experience Act of 2014 (“ABLE Act”) will be accessible for the first time through the MSRB’s Electronic Municipal Market Access (“EMMA”) website. The offering documents will be made available on EMMA both by states on a voluntary basis and by municipal securities dealers involved in the primary offering of ABLE Programs, as required by MSRB regulations. MSRB Press Release

National Futures Association

NFA Notifies Members of Effective Date for Late Fee for NFA Forms PQR and PR Filings

On June 21st, the National Futures Association (“NFA”) announced the effective date for recent amendments to NFA Compliance Rule 2-46, which will impose a $200 late fee on commodity pool operator or commodity trading advisor members for each business day they file their quarterly NFA Form PQR or PR after the due date. The late fee will be effective for all NFA Forms PQR and PR beginning with reports dated September 30, 2016, and later.NFA Notice I-16-16

Judicial Developments

SEC Properly Found That Dark Pool Hopeful Pursued Too Much Self-Regulatory Power

Automated Matching Systems Exchange (“AMSE”) appealed a final agency order by the SEC denying AMSE’s application for a limited volume exemption from registration as a national securities exchange under Sec. 5 of the Exchange Act and the district court’s dismissal of AMSE’s complaint for lack of jurisdiction. The Eighth Circuit affirmed on June 20th, holding that the SEC reasonably concluded that the Act does not permit an exempt exchange to operate with the self-regulatory powers AMSE proposed in its application, and that the district court lacked jurisdiction to consider AMSE’s claims. SEC

Industry News

OIG Is Reviewing Fed’s Cybersecurity Oversight

According to CFO on June 21st, the Office of Inspector General (“OIG”) of the Federal Reserve’s Board of Governors is reviewing the U.S. central bank’s oversight of financial institutions’ information security controls and cybersecurity threats. The OIG, which will release its audit in the fourth quarter, wrote that “[t]he growing sophistication and volume of cybersecurity threats presents a serious risk to all financial institutions.” Reuters reported on June 20th that the Fed is facing scrutiny after cyber criminals stole $81 million from a New York Fed account held by the central bank of Bangladesh. Reuters added that the central bank is facing further scrutiny about its own cybersecurity practices after a Reuters report revealed more than 50 cyber breaches at the Fed between 2011 and 2015.