Insights from Winston & Strawn

Wall Street banks ask the Fed for five more years to comply with Volcker Rule

Wall Street banks have asked the Federal Reserve Board (“Fed”) to grant them an additional five-year grace period to comply with section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule.  The added extension would give banks until 2022 to exit “illiquid” fund investments.

The Volcker Rule—one of the key provisions of the extensive 2010 Dodd-Frank financial reforms—aims to reduce risk-taking by limiting banks’ ability to engage in more speculative trading through prohibitions on investing in certain private equities and hedge funds.  However, critics maintain that the rule’s many loopholes, such as exemptions for merchant banking and foreign exchange trading, have diluted the impact of the rule.

The Fed has already granted three one-year extensions for compliance with a broader provision of the Volcker Rule regarding stakes in hedge funds and private equity funds—the maximum number of extensions it could provide in that context.  The law on Volcker Rule implementation allows banks to request an extra five-year extension for “illiquid” funds, where banks had contractual commitments to invest. In deciding whether to grant the request, the Fed has asked banks to supply additional information on their specific investments to prove that they fall under the statutory definition of “illiquid.”  The Fed has also asked how long it would take to unload these investments and what could be done to unload them more quickly.

Banks have been selling down prohibited investments over the last several years, but have noted in regulatory filings that they may face difficulty in getting rid of certain investments by upcoming deadlines—some investments do not contractually expire for years or lack a liquid market for an immediate sale.  Further, banks maintain that the July 2017 deadline may force them to accept discounted prices.

If the Fed grants the extension, it risks criticism for giving Wall Street too much leeway and allowing banks to evade rules and regulatory oversight.  However, the Fed also risks blame for causing fire-sale losses and entangling investor clients in litigation regarding breaking contractual agreements.  Further delay may also provide opponents with time and ammunition to promote alternative financial reform initiatives.  In June, Republicans unveiled a legislative proposal that would dismantle significant portions of Dodd-Frank.  Additionally, both political parties have discussed reinstating the Depression-era Glass-Steagall Act, which required the separation of investment banking from commercial banking.

Feature: Recent Anti-Money Laundering Development

At the end of July, the Financial Crimes Enforcement Network (“FinCEN”) announced that it would issue additional orders under an initiative it says is part of a “risk-based approach to combating money laundering in the real estate sector.” FinCEN launched the initiative last March by requiring certain U.S. title companies to identify the natural persons behind companies involved in all-cash real estate purchases in high-end residential real estate in the New York City borough of Manhattan and in Miami, Florida. The first wave of geographical targeting orders (“GTOs”), which are set to expire at the end of August, represented what FinCEN officials call an “incremental approach” to regulating anti-money laundering compliance in the real estate sector, which the Wall Street Journal noted is regulated primarily by states, which have historically fought federal money-laundering controls. FinCEN indicated that the initial orders confirmed its concerns about money laundering in all-cash luxury purchases of residential property. FinCEN’s goal in expanding the initiative is to gauge the extent to which these money laundering risks extend to the national real estate market. The new GTOs target an expanded list of geographic areas, including all New York City boroughs, Los Angeles, San Diego, San Antonio, San Francisco and its surrounding areas, and two counties north of Miami. The financial thresholds for transactions vary according to geographic region and range from $500,000 in the San Antonio area to $3 million in Manhattan. The new GTOs will become effective for 180 days beginning on August 28, 2016.

FinCEN is preparing to reissue a proposed rule targeting money laundering risks associated with gift and other prepaid cards. In November 2014, FinCEN withdrew the proposal, which would have required the funds stored on prepaid cards to be included under U.S. reporting requirements for the cross-border movement of $10,000 or more in cash. Reuters reported that FinCEN pulled the rule following a meeting with representatives from the prepaid card industry, who argued that the proposed rule would discourage consumers from using the cards. FinCEN spokesman Stephen Hudak indicated that the agency is reworking the proposed rule and may resubmit the proposal as soon as next year.

The New York Department of Financial Services (“NYDFS”) recently finalized a risk-based regulation that will require institutions to implement programs to monitor transactions for potential Bank Secrecy Act and anti-money laundering violations and prevent transactions with sanctioned entities. The final rule requires institutions to maintain a transaction monitoring program that is based on a risk assessment of the institution to ensure that the program adequately matches the institution’s anti-money laundering risks to its businesses, products, services and customers. Institutions will be required to conduct ongoing testing of the program’s detection scenario logic and model validation, among other things. The final rule also requires that institutions submit a board resolution or senior officer compliance finding that certifies the effectiveness of the transaction monitoring and filtering program to the NYDFS on an annual basis. As Dan Ryan of PricewaterhouseCoopers observed in a recent blog post, the NYDFS revised the certification requirement in response to industry feedback by allowing a senior officer or the board to submit the annual certification and removing a provision that would have imposed criminal penalties for incorrect or falsified certifications. The Wall Street Journal noted that the new regulations could give the NYDFS more flexibility in pursuing anti-money laundering violations than some other federal banking regulators. The new rule will become effective on January 1, 2017.

The EU is also taking additional measures to strengthen its anti-money laundering rules. Last month, the European Commission announced proposed amendments to its Fourth Anti-Money Laundering Directive to increase transparency about the beneficial ownership of companies and business-related trusts.  Among other things, the proposed changes would require EU member states to make public certain information from the beneficial ownership registers, which will apply to beneficial owners who have 10 percent ownership in companies that present a risk of being used for money laundering and tax evasion. The proposal also recommends changes to enhance protections against terrorism financing, which would extend customer due diligence requirements to virtual currency platforms, lower the identification thresholds on prepaid cards from €250 to €150, expand customer verification requirements for prepaid cards, and require banks to carry out additional due diligence measures on financial flows from countries with deficiencies in their anti-money laundering and countering terrorist financing regimes. 

International regulators are looking for ways to help banks comply with stricter money-laundering regulations. Last month, the Committee on Payments and Market Infrastructure (“CPMI”) published its final report on correspondent banking, which proposes measures to prevent the fragmentation of cross-border payment networks. As Reuters reported, the CPMI recommended the creation of “know-your-customer” databases that would serve as a central repository for customer information from across the banking sector. All banks would have access to the same customer information, which would save banks time and money. The CPMI indicated that it would work with other regulators to define the standard information that the proposed databases would collect to help banks comply with their anti-money laundering and counter terrorist financing obligations.

Banking Agency Developments

Office of the Comptroller of the Currency

OCC to Host St. Louis Workshop for Bank Directors

On August 9th, the Office of the Comptroller of the Currency (“OCC”) announced that it will host a Building Blocks for Directors workshop in St. Louis at the Renaissance St. Louis Airport Hotel, September 19-21, for directors of national community banks and federal savings associations supervised by the OCC. The workshop will combine lectures, discussion, and exercises to provide practical information on the roles and responsibilities of board participation for both new and experienced directors, and will focus on directors’ duties and core responsibilities, discuss major laws and regulations, and increase familiarity with the examination process.

Securities and Exchange Commission

Staff Announcements

Kristin Snyder will serve as the Co-National Associate Director of the Investment Adviser/Investment Company examination program in the Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”), according to an announcement by the SEC on August 10th. Snyder will continue in her position as Associate Regional Director for Examinations in the SEC’s San Francisco office after assuming her new role in the national investment adviser/investment company program. SEC Press Release.

SEC Releases San Francisco Compliance Outreach Program Agenda

On August 5th, the SEC announced the agenda for the San Francisco Compliance Outreach Program for Broker-Dealers. The San Francisco regional program, which will be held on August 18, 2016, will include two panels focused on cyber-security threats impacting broker-dealers and conflict management frameworks.

Commodity Futures Trading Commission

CFTC Proposes to Amend Timing for Filing CCO Annual Reports by Certain Registrants

On August 9th, the U.S. Commodity Futures Trading Commission (“CFTC”) announced proposed amendmentsto CFTC regulation 3.3, which would provide futures commission merchants, swap dealers, and major swap participants additional time to file chief compliance officer annual reports and clarify the timing of the filing requirements applicable to swap dealers and major swap participants located in certain jurisdictions. If adopted, the proposed rule would effectively codify and supersede CFTC Staff Letter No. 15-15, which was issued in 2015. Pursuant to the Federal Register, comments on the proposal must be received by September 12, 2016.

CFTC Announces Enhancements to Protect Customer Funds

On August 8th, the CFTC announced three separate measures that are designed to enhance the protection of customer funds. The CFTC approved an order to exempt Federal Reserve Banks that maintain customer accounts for derivatives clearing organizations (“DCOs”) from liability under the Commodity Exchange Act (“CEA”). In addition, the CFTC’s Divisions of Clearing and Risk (“DCR”) and Swap Dealer and Intermediary Oversight (“DSIO”) issued separate interpretative and no-action letters regarding the use of money market funds by DCOs and futures commission merchants. The exemption enables the use of Federal Reserve Banks by DCOs that have been designated by the Financial Stability Oversight Council as systemically important. The exemption permits the Federal Reserve Banks to hold such DCOs’ customer funds without being subject to liability under the CEA. The customer funds must not be commingled with the money, securities, or property in the account of any other person. The order also exempts the Federal Reserve Banks from private rights of action that could otherwise be brought under the CEA. CFTC Final Rule on Written Acknowledgment of Customer Funds from Federal Reserve Banks.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Chicago Board Options Exchange

CBOE Gains SEC Approval to Expand its Nonstandard Expirations Pilot Program

On August 10th, the SEC approved a proposed rule change filed by the Chicago Board Options Exchange, Incorporated (“CBOE”) that will expand the End of Week/End of Month Pilot Program to permit P.M.-settled options on broad-based indexes to expire on any Monday of the month other than Mondays that coincide with the last trading day of the month. SEC Release No. 34-78531

Depository Trust Company

DTC Proposes Option to Submit a Cover of Protect on Behalf of Another Participant

On August 9th, the SEC requested comments on The Depository Trust Company’s (“DTC”) proposal to add an option called “Cover of Protect on Behalf of Another Participant” to its Participant Subscription Offer and Participant Tender Offer Programs. The proposal would allow a Participant to tender subscription rights or securities through DTC to an Offer Agent on behalf of another Participant that must tender these rights or securities to receive the shares and/or consideration from a Rights Offer or a Tender/Exchange Offer. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of August 15, 2016. SEC Release No. 34-78520

Financial Industry Regulatory Authority

FINRA Proposal Would Require Arbitration Participants to Make Filings through FINRA’s Party Portal

On August 11th, the SEC requested comments on a proposed rule change filed by the Financial Industry Regulatory Authority (“FINRA”) that would amend its Code of Arbitration Procedure for Customer Disputes and its Code of Arbitration Procedure for Industry Disputes. The proposed changes would require all parties, except customers who are not represented by an attorney, to use the FINRA Office of Dispute Resolution’s Party Portal to file initial statements of claim and to file and serve pleadings and other documents on FINRA or any other party. The proposed amendments would not apply to documents produced in response to discovery requests. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of August 15, 2016. SEC Release No. 34-78549

SEC Seeks Comments on Proposed Changes to FINRA’s Arbitration Procedures for Motions to Dismiss

On August 11th, the SEC provided notice of a proposed rule change filed by FINRA that would amend its arbitration procedure codes to provide that arbitrators may act upon a motion to dismiss a party or claim prior to the conclusion of a party’s case if the arbitrators determine that the non-moving party previously brought a claim regarding the same dispute against the same party, and the dispute was previously concluded through adjudication or arbitration and memorialized in an order, judgment, award, or decision. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of August 15, 2016.SEC Release No. 34-78553

SEC Approves FINRA’s Proposal to Permit Award Offsets in Arbitration

On August 11th, the SEC issued an order granting accelerated approval to FINRA’s proposed rule change that would amend its arbitration procedure codes to provide that absent specification to the contrary in an arbitration award, when arbitrators order opposing parties to pay each other payments, the monetary awards shall offset, and the party that owes the larger amount shall pay the net difference. FINRA amended the approved proposal by replacing the word “damages” with “payments” in order to capture those portions of awards attributable to amounts other than damages. SEC Release No. 34-78557

FINRA Clarifies Definition of “Time of Execution” for Reporting Transactions in TRACE-Eligible Securities

FINRA published a Regulatory Notice on August 10th that offers guidance to firms about their obligation under FINRA rules to report accurately the time of execution for transactions in TRACE-eligible securities. FINRA clarified that the “time of execution” in these transactions generally refers to the time at which the parties to the transaction agree to all of the material terms sufficient to calculate the dollar price of the trade. FINRA Regulatory Notice 16-30

FINRA Seeks Comments on Proposed Changes to Gifts, Gratuities and Non-Cash Compensation Rules

On August 8th, FINRA proposed changes to its rules on gifts, gratuities and non-cash compensation rules. Among other things, FINRA has proposed to consolidate the rules under a single rule series, incorporate existing guidance into the rules, amend the non-cash compensation rules to cover all securities products, and increase the gift limit from $100 to $175 per person per year and include a de minimis threshold below which firms would not have to keep records of gifts given or received. Comments should be submitted on or before September 23, 2016. FINRA Regulatory Notice 16-29

FINRA Asks ATSs to Prepare for Additional Order Reporting Requirements

FINRA published a Regulatory Notice on August 8th in which it reminded alternative trading systems that they will be required to submit additional order information to FINRA under new rules effective on November 7, 2016. FINRA directed all ATSs to submit a list of their current order types no later than October 19, 2016, to assist FINRA in mapping order identifiers to specific order types prior to the rule’s effective date. FINRA Regulatory Notice 16-28

ICE Clear Credit

SEC Approves Changes to ICC’s End-of-Day Price Discovery Policies and Procedures

On August 8th, the SEC issued an order approving ICE Clear Credit LLC’s (“ICC”) proposed rule change that would revise its End-of-Day Price Discovery Policies and Procedures by changing the calculation of single name firm trade notational limits to be at a Clearing Participant affiliate group level. SEC Release No. 34-78501

National Futures Association

NFA Encourages FCM and IB Members to Prepare for New Beneficial Owner Identification Requirements

On August 12th, the National Futures Association (“NFA”) published a notice that summarizes FinCEN’s final rules relating to customer due diligence requirements, which will require the NFA’s futures commission merchant (“FCM”) and introducing broker (“IB”) members to identify and verify the identity of beneficial owners of legal entity customers. The NFA indicated that it would amend NFA Compliance Rule 2-9 and a related Interpretative Notice entitled FCM and IB Anti-Money Laundering Program to reflect the changes prompted by FinCEN’s rules. NFA Notice I-16-17]


NYSE Exchanges’ Proposals Would Permit Rejection of Certain Electronic Complex Orders

On August 11th, the SEC requested comments on NYSE MKT LLC’s (“NYSE MKT”) and NYSE Arca, Inc.’s(“NYSE Arca”) separately filed proposals to amend their respective rules to provide for the rejection of certain directional Electronic Complex Orders that may undermine the effectiveness of risk limitation mechanisms designed to protect Market Makers. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of August 15, 2016.

NYSE Exchanges Propose Amendments to Disaster Recovery Plans

On August 5th, the SEC provided notice of the New York Stock Exchange LLC’s (“NYSE”) and NYSE MKT’s separately filed proposals to amend their respective rules governing their current disaster recovery plans. The proposals would eliminate the provision that designates NYSE Arca to act on their behalf and instead permit the exchanges to operate as fully electronic exchanges under their own trading rules and to maintain their own order books in their disaster recovery facilities. Comments should be submitted on or before September 1, 2016.

Judicial Developments

Disclosure-Only Settlements in Shareholder Suits Must Show a ‘Plainly Material Misrepresentation or Omission.’

On August 10th, the Seventh Circuit reversed approval of a disclosure-only settlement between Walgreen Co. and a class of investors, determining that disclosure-only settlements in shareholder suits need to expose a “plainly material misrepresentation or omission.” The panel noted that “[t]he type of class action … that yields fees for class counsel and nothing for the class — is no better than a racket. It must end … [n]o class action settlement that yields zero benefits for the class should be approved, and a class action that seeks only worthless benefits for the class should be dismissed out of hand.” Walgreen.

Panel Dismisses Suit Brought by Aluminum Buyers for Lack of Antitrust Standing

Aluminum purchasers alleged that banks conspired to manipulate the price of aluminum. On August 9th, the Second Circuit agreed with the district court that the aluminum commercial manufacturers and purchasers lacked standing to sue because they failed to show that they were targeted by the alleged conspirators in an effort to hurt competitors. The panel stated that “[n]one of these acts inflicted direct injury on consumers or commercials; the injury consumers and commercials claim was suffered down the distribution chain of a separate market, and was a purely incidental byproduct of the alleged scheme.” Aluminum

SEC’s ALJs Do Not Violate Appointments Clause, as they Are Employees Who Do Not Issue Final Decisions

The SEC instituted an enforcement action against petitioners, alleging violations of the Investment Advisers Act. Upon granting a petition for review of an initial ALJ decision, the SEC rejected petitioners’ argument that the ALJ was unconstitutionally appointed. In a petition for review, petitioners argued that the ALJ was a constitutional officer who must be appointed under the appointments clause. The D.C. Circuit denied the petition on August 9th, holding that SEC ALJs do not violate the appointments clause since they act as employees who do not issue final decisions, and not as officers of the U.S. SEC.

Industry News

World Economic Forum Releases Report Endorsing Bitcoin Technology

On August 12th, the World Economic Forum released its 130-page report, “The Future of financial infrastructure: An ambitious look at how blockchain can reshape financial services,” in which it predicted that the core technology introduced by the virtual currency Bitcoin will come to occupy a central place in the global financial system. The report estimated that 80% of banks around the world could start blockchains (or “distributed ledgers” as they are often described) by next year. The report added that the technology could help improve both mainstream transactions, like global payments and stock trading, as well as lesser-known areas such as trade finance and contingent convertible bonds. DealBook noted that this is one of the strongest endorsements yet for the blockchain, which is run by a network of users (much like Wikipedia) instead of being updated and maintained by a single company or government. Giancarlo Bruno, the head of financial services industries at the World Economic Forum, indicated that “[r]ather than to stay at the margins of the finance industry blockchain will become the beating heart of it.”

SEC Rules to Make Money Market Funds Saferare Impacting Short-Term Borrowers

On August 8th, the Wall Street Journal reported on the SEC’s move to make money market funds safer in the wake of the financial crisis. The new rules, which go into effect on October 14th, require prime funds and tax-exempt funds that invest in municipal debt to abandon implied guarantees that institutional investors will get their money back. The new rules will also allow the funds to suspend redemptions temporarily in a crisis. According to the article, funds worried about outflows are sitting on cash and are reluctant to buy debt that matures after the October deadline.