Insights from Winston & Strawn

The concept of expanding access to capital for small and medium-size businesses – and allowing ordinary investors access to invest in such businesses – is a popular topic these days, and not just in the United States.  

On the heels of the SEC’s release on October 30 of new U.S. crowdfunding rules (known as “Regulation Crowdfunding”) (discussed in last week’s Financial Services Update newsletter) that will permit ordinary investors to invest in startup companies, the Ontario Securities Commission on Thursday, November 5 announced its own crowdfunding exemption and regulatory framework for funding platforms. These rules are intended to be complementary to similar exemptions previously adopted by the securities regulatory authorities for Manitoba, Québec, New Brunswick, and Nova Scotia in May 2015, and are expected to come into effect on January 25, 2016. The National Post’s report on the new rules can be found here.  

Similar to the SEC’s Regulation Crowdfunding rules, under the new Canadian rules securities issuers in the participating provinces will be required to distribute their securities through a funding portal that is registered with government authorities, issuers will be subject to reporting requirements, and the maximum amount that a person may invest will be dictated by the investor’s income and financial resources. However, the specific rules and investment limitations differ somewhat for issuers, portals, and investors.  

Per the National Post, in addition to crowdfunding, Ontario securities rules will also separately permit small and medium-size businesses to raise capital from friends and family or the issuer’s existing securities holders through the issuance of a prospectus, as well as via sales conducted by way of an offering memorandum, a document that is generally “less onerous and costly” than a prospectus.

Feature: Reactions to the New Crowdfunding Rule

“It’s official: Your grandma can soon invest in startups,” said Fortune on October 30th, the day the SEC adopted new rules, titled “Regulation Crowdfunding,” that are aimed at helping smaller companies with capital formation and offering investors additional protections. The SEC voted 3-1 to approve equity-based crowdfunding rules, approximately three years after its original deadline to do so. Republican SEC Commissioner Michael Piwowar registered the lone vote against the crowdfunding initiative, saying that the new rules were too strict, will discourage many companies from participating, and are overly paternalistic. Piwowar further contended that, by restricting the amount that people can invest, the SEC “cannot trust ordinary Americans … to be able to exercise appropriate judgment in how to spend or invest their resources.”  

Under the new rule, small businesses will be allowed to raise up to $1 million per year from the general public through online portals registered with the SEC. Until now, the rules only permitted businesses to accept investments from “accredited investors,” i.e., generally those with either a net worth of at least $1 million or with an annual income of at least $200,000. But, once the Regulation Crowdfunding rules go into effect in 2016, just about anybody will be able to invest.  

Notably, however, in order to protect smaller investors from, for instance, putting all of their retirement savings into a promising investment that doesn’t pan out, the SEC rules include specific limits regarding how much a non-accredited investor can invest per 12-month period. Under the rules, anyone can invest at least $2,000, but investors may only invest greater than that amount based on their annual income and net worth. Persons cannot invest more than $100,000 through all crowdfunding offerings in any 12-month period.

A Crowdfunding Website That Foresees the Benefits of the New Rule

Some equity-based crowdfunding platforms, such as Crowdfunder and Fundable, preceded Regulation Crowdfunding rules, but their services were available only to investors that qualified under the prior rules. The new rules make it easier for small businesses and individual investors to participate, although all platforms to connect businesses and investors must be registered through SEC and will be subject to their own set of new rules. Many platforms, such as, CrowdfundX, SeedInvest and OfferBoard, have said they are eager to participate in this “democratization of the capital formation process for small companies.”  

Some larger fundraising sites, such as Indiegogo, which has been lobbying for crowdfunding for years and is enthusiastic about the new rules, may also participate. Slava Rubin, CEO and co-founder of Indiegogo, stated that “[a]ll of us at Indiegogo are excited that the SEC is formally expanding the way in which everyone will be able participate in the entrepreneurial ecosystem through the amazing power of crowdfunding … We’re now exploring how equity crowdfunding may play a role in Indiegogo’s business model.” Rubin continued, “[i]t’s going to benefit a whole lot of companies – it could be the local coffee shop, and there will [be] opportunities for really interesting hardware and tech companies.”  

In addition, the Wall Street Journal and CNBC reported on November 4th that Seedrs, a European crowdfunding company, will launch in the U.S. when the Regulation Crowdfunding rules become effective. “We believe this heralds the emergence of equity crowdfunding as a vibrant form of finance in the United States – just as it has become in the U.K. and Europe – and Seedrs is perfectly positioned to take advantage of the sector’s growth,” said Jeff Lynn, CEO of Seedrs, in a press release.

Investment vs. Donation

Had the new rule been in place years ago, donors to at least one successful startup company might have received a return on an investment rather than a “thank you” card.  

In a story noted by the Los Angeles Times, virtual reality headset developer Oculus raised $2.4 million from nearly 10,000 donors on Kickstarter in 2012.  Because the Regulation Crowdfunding rules were not in place at the time, the donors did not receive equity in Oculus in exchange for their money; instead, they essentially made a donation to the company. After Facebook subsequently bought Oculus for $2 billion, donorsreceived a “thank you” card from the company or an unassembled prototype of the company’s Rift headset. Under the new Regulation Crowdfunding rules, investors will instead be able to invest in a company’s equity, and, if the company succeeds, perhaps earn a return on that investment.

Initial Doubts

Just a week after the adoption of the new rules, it is becoming clear that not everyone shares the same optimism about the new rules.Many critics noted that many start-ups fail, and the new rule will allow inexperienced investors to invest in firms that have little oversight. Some critics warn this can be a problem, despite the SEC’s assertions that it will supervise the evolving crowdfunding environment. Other critics, including the Huffington Post’s Business Blog, have expressed their own doubts about the new rule, comparing its adoption to what happened during the Great Depression of the 1930s, when the SEC was formed in an effort to regain market stability.  

Other critics believe that the rules placed on companies and investors with respect to the crowdfunding process – such as requirements on companies’ financial reporting, a 21-day mandatory “cooling off” period between applying to and starting fundraising, and the annual income/net worth restrictions on investors – will conspire to limit the new rules from having a substantial impact.  

Several crowdfunding websites not only have their doubts about the new rule, but they are also refusing to get on board with it. According to Financial Times, such websites, including Kickstarter, have stated that they will not open up their platforms to enable entrepreneurs  to raise equity following the SEC’s “liberalization.” AngelList, a similar platform that is aimed at more experienced and “accredited” investors, has noted that it will not lower its wealth threshold to take advantage of the new rules.

What You Need to Know Now

The SEC rules will go into effect 180 days after they are published in the Federal Register, and portals will be able to register with the SEC starting on January 29, 2016.

Banking Agency Developments


Comptroller Discusses Increasing Credit Risk Facing Federal Banking System

On November 2nd, Comptroller of the Currency Thomas J. Curry spoke at the Risk Management Associations’ Annual Risk Management Conference, where he discussed increasing credit risk facing the federal banking system. Curry Remarks.

Five Federal Agencies Finalize Swap Margin Rule

On October 30th, the Office of the Comptroller of the Currency (“OCC”) announced that it, along with the Farm Credit Administration (“FCA”), the Federal Deposit Insurance Corporation (“FDIC”), the Federal Housing Finance Agency (“FHFA”), and the Federal Reserve, have issued a final rule to establish capital and margin requirements for swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants regulated by one of the agencies as required by the Dodd-Frank Act. The final rule establishes minimum margin requirements for swaps and security-based swaps that are not cleared through a clearinghouse. The final rule will phase in the variation margin requirements between September 1, 2016 and March 1, 2017. The initial margin requirements will phase in over four years, beginning on September 1, 2016. The agencies also issued an interim final rule relating to the rule’s exemption from margin requirements for certain non-cleared swaps and non-cleared security-based swaps used for hedging purposes by commercial end-users and certain other counterparties. The regulation was issued as an interim final rule, as required by the law passed by the Congress in January 2015. The public is invited to submit comments on the interim final rule through January 31, 2016. OCC Press Release.


FFIEC Releases Statement on Cyber Attacks That Involve Extortion

On November 3rd, the Federal Financial Institutions Examination Council (“FFIEC”) issued a statement alerting financial institutions to the increasing frequency and severity of cyber attacks involving extortion. The statement describes steps financial institutions should take to respond to these attacks and highlights resources institutions can use to mitigate the risks posed by such attacks. FFIEC Press Release.

Securities and Exchange Commission

Proposed Rules

SEC Proposes Changes to Rules Governing Intrastate Offerings and Rule 504 of Regulation D

At its Open Meeting on October 30th, the SEC voted to propose amendments to Securities Act Rule 147, which provides a safe harbor for intrastate offerings of securities exempt from registration under Section 3(a)(11) of the Securities Act, and Rule 504 of Regulation D. The proposed revisions to Rule 147 would allow issuers to advertise offerings using any form of mass media that could potentially reach out-of-state residents provided the securities are only offered or sold to residents of the state in which the issuer has its principal place of business; replace the “principal office” requirement under the current rule with the requirement that an issuer maintain a “principal place of business” in the state in which it conducts an offering; limit the amount of securities an issuer may sell to no more than $5 million in a 12-month period; and place an investment limitation on investors. The proposed amendments to Rule 504 of Regulation D would increase the amount of securities offered and sold under Rule 504 from $1 million to $5 million in a 12-month period and extend bad actor disqualifications to participants in Rule 504 offerings. Comments should be submitted within 60 days of publication in the Federal Register. SEC Press Release. In conjunction with the proposed rules, the SEC’s Division of Economic and Risk Analysis (“DERA”) published a white paper entitled “Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009-2014,”which examines the characteristics of offerings conducted under Regulation D from 2009-2014. The proposed rules received support from Chair White and Commissioners Aguilar and Stein, although Commissioner Stein expressed concern that the changes to Rule 147 may diminish the local nature of the offerings that served as the impetus for the original exemption. Commissioner Piwowar dissented from the proposed amendments, objecting to the condition that issuers meet certain percentage thresholds to determine the in-state nature of their business and the limitations placed on the exempt offering amount and the amount an investor may invest.

Exemptive Orders and No-Action Relief

SEC Grants Conditional Exemption from Compliance with Large Trader Reporting Requirements

On October 30th, the SEC issued an order in response to requests submitted by the Financial Information Forum and the Securities Industry and Financial Markets Association (“SIFMA”) asking the SEC to exempt options traders from requirements under Rule 13h-1 of the Securities Exchange Act, which requires large traders to identify themselves and certain broker-dealers to report large trader transaction information, and to either exempt broker-dealers from the reporting requirements of Phase Three of the rule or extend the compliance date. The SEC granted a conditional exemption from the requirements of Rule 13h-1 to equity options traders that have not exceeded the identifying activity level based on the gross premium of the options trades. The SEC also extended the compliance date for the remaining recordkeeping and reporting requirements of Phase Three until November 1, 2017. SEC Release No. 34-76322.


SEC Offers New Guidance on Critical Systems under Regulation SCI

On October 30th, the SEC updated its responses to frequently asked questions (“FAQs”) regarding Regulation SCI. The updated guidance includes answers to questions regarding whether market regulation and surveillance systems used by alternative trading systems meet the definition of an SCI system, the meaning of “exclusively-listed securities” in the definition of critical SCI systems, and which SCI systems that communicate trading halts qualify as critical SCI systems. Regulation SCI FAQs.

Speeches and Statements

Director of Enforcement Offers Reassurance to Compliance Officers

On November 4th, SEC Division of Enforcement Director Andrew Ceresney delivered a keynote address at the 2015 National Conference of the National Society of Compliance Professionals. In his remarks, Ceresney provided an overview of the SEC’s approach to enforcement actions that involve compliance professionals, specifically in the investment adviser sector. Ceresney sought to reassure compliance personnel that the SEC has not altered its approach in determining whether to charge compliance officers, noting that these enforcement actions are rare and involve clear cases of misconduct or negligence. Ceresney Remarks.

White Emphasizes Importance of Data Analysis in Global Enforcement Effort

On November 2nd, SEC Chair Mary Jo White discussed how new opportunities to use data analytics in identifying potential misconduct, along with international cooperation and collaboration, has strengthened the SEC’s global enforcement efforts in opening remarks to the 21st Annual International Institute for Securities Enforcement and Market Oversight. White Remarks.

Ceresney Outlines Market Structure Enforcement Priorities in the Age of Automation

In remarks delivered to the SIFMA Compliance & Legal Society New York Regional Seminar on November 2nd, SEC Division of Enforcement Director Andrew Ceresney discussed how the SEC has responded to new threats to investors and markets brought about by the increased speed and automation associated with innovations in market structure. Ceresney highlighted four types of threats that have been the subject of recent SEC enforcement actions and that the Division of Enforcement will continue to prioritize, including violations by exchanges and alternative trading systems (“ATSs”) that have undermined fairness in trading venues; misuse of confidential customer order information by dark pools and other ATSs; failures to maintain adequate safeguards around automated trading systems in violation of the market access rule; and schemes involving high volume manipulation, including layering and spoofing. Ceresney also emphasized that market structure investigations increasingly require an understanding of the underlying technology and the ability to analyze extremely large datasets. Ceresney Remarks.

Other Developments

SEC Alerts Investors to Role of Social Media in Perpetrating Securities Fraud

On November 5th, the SEC’s Office of Investor Education and Advocacy published an Investor Alert to warn investors regarding the use of social media by fraudsters to spread false information regarding stocks in order to manipulate markets. The alert highlighted recent enforcement actions in which individuals used social media to engage in market manipulation. The alert listed several red flags for investors to note when considering investment offers made through social media outlets. SEC Investor Alert.

Staff Announcements

On November 5th, the SEC announced that Bryan Bennett will head the examination program in its Los Angeles Regional Office. SEC Press Release.

SEC Awards More Than $325,000 to an Investment Firm Whistleblower

On November 4th, the SEC announced that it has awarded over $325,000 to a whistleblower at an investment firm who provided specific information leading to an investigation of fraudulent activity at the firm and successful enforcement action. SEC officials noted that the amount of the award would have been higher if the whistleblower had not delayed reporting the misconduct to the SEC until after resigning from the firm. SEC Commission Notice 34-76338.

Commodity Futures Trading Commission

CFTC Staff Publishes Responses to FAQs Regarding Forms CPO-PQR and CTA-PR

On November 5th, CFTC staff responded to frequently asked questions regarding Commission Form CPO-PQR and Form CTA-PR on filing mechanics and filing deadlines as well as technical questions regarding asset reporting classification. CFTC Press Release.

Division of Market Oversight Extends Time-Limited No-Action Relief for Swap Execution Facilities from Certain ‘Block Trade’ Requirements

On November 2nd, the CFTC’s Division of Market Oversight (“Division”) extended time-limited no-action relief to Swap Execution Facilities (“SEFs”) from certain requirements in the definition of “block trade” in CFTC regulation Sec. 43.2. The No-Action Letter extends time-limited relief to SEFs from the “occurs away” requirement under Sec. 43.2 until November 15, 2016. The extended relief, which is subject to several conditions, will provide the Division staff time to continue to review and evaluate SEF trading practices and functionalities for pre-execution credit checks. The extension will also allow the Division to consider, develop and evaluate best practices and more permanent solutions to the issues involved in screening block trade orders for compliance with risk-based limits including, if appropriate, amendments to CFTC regulations. CFTC Press Release.

Federal Rules Effective Dates

Click here to view table.

Exchanges and Self-Regulatory Organizations

Chicago Board Options Exchange

CBOE Seeks Approval to List and Trade Options that Overlie a Reduced Value of the FTSE China 50 Index

On November 4th, the SEC announced a proposed rule change filed by the Chicago Board Options Exchange, Inc. (“CBOE”) that would allow CBOE to list and trade options that overlie a reduced value of the FTSE China 50 Index, a free float-adjusted market capitalization index that is designed to measure the performance of 50 of the largest and most liquid Chinese stocks listed and traded on the Stock Exchange of Hong Kong. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015. SEC Release No. 34-76354.

CBOE Files Proposal to List and Trade Options that Overlie a Reduced Value of the FTSE 100 Index

On November 4th, the SEC announced a proposal by CBOE to amend its rules to list and trade options that overlie a reduced value of the FTSE 100 Index, a free float-adjusted market capitalization index that is designed to measure the performance of the 100 largest companies traded on the London Stock Exchange. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015. SEC Release No. 34-76353.

Financial Industry Regulatory Authority

SEC Approves FINRA’s Proposal to Shorten Waiting Period for Release of Form U5 Information

On November 5th, the SEC approved a proposed rule change submitted by the Financial Industry Regulatory Authority (“FINRA”) that will reduce the 15-day waiting period for the release of information reported on Form U5 (Uniform Termination Notice for Securities Industry Registration) through BrokerCheck. Under the rule amendments, FINRA will not release events reported on Section 7 of Form U5 for three business days after FINRA has processed the form. The revised rule contains an exception for events also reported on Form U4, which allows for Form U5 to be released concurrently with Form U4 even if the three-business-day period has not yet expired. SEC Release No. 34-76359.

FINRA Announces Availability of and Changes to the Online CE Program for the S101 Regulatory Element

On November 4th, FINRA notified firms and registered representatives of impending changes to the S101 Regulatory Element Continuing Education (“CE”) Program. According to the notice, the CE Online Program will be available beginning on January 4, 2016, to those who have an S101 CE enrollment window that is open on that date. The S101 Regulatory Element CE Program will also include revisions that will allow participants to self-select a module based on job function. FINRA Information Notice.

Shortened TRACE Reporting Period for ABS Transactions Will Begin December 7

On November 4th, FINRA issued a reminder that starting on December 7, 2015, asset-backed security transactions must be reported no later than 15 minutes from the time of execution, with exceptions in place for transactions executed shortly before or during the closure of the TRACE system. FINRA Press Release.

FINRA Launches Electronic Platform for Subordination Submissions

On November 2nd, FINRA announced that it is replacing the current hard copy submission process for requests to approve proposed or renew existing subordinated loan agreements and secured demand note agreements (“subordinations”) with a new electronic platform. All subordination requests must be submitted through the electronic platform on Firm Gateway effective November 30, 2015. FINRA Regulatory Notice 15-42.

ICE Clear Credit LLC

ICC Proposes Clarifying Changes to Its Risk Management Framework Documentation

On November 3rd, the SEC provided notice of ICE Clear Credit LLC’s (“ICC”) proposed rule change that would reorganize its Risk Management Framework (“RMF”) to improve the governance of its risk management documentation, including making clarifying and organization revisions to the RMF and the Treasury Operations Policies and Procedures and adopting a new Risk Management Model Description Document. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015. SEC Release No. 34-76331.

International Securities Exchange

ISE and ISE Gemini Submit Proposals to Comply with Disaster Recovery Plan Testing under Regulation SCI

On November 3rd, the SEC requested comment on separate proposals submitted by International Securities Exchange LLC (“ISE”) and ISE Gemini LLC (“ISE Gemini”) to amend their respective rules to comply with requirements under Rule 1004 of Regulation SCI. The proposed changes would require designated members to participate in scheduled and functional testing of disaster recovery and business continuity plans. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015.

International Swaps and Derivatives Association

ISDA Launches 2015 Section 871(m) Protocol

On November 2nd, the International Swaps and Derivatives Association (“ISDA”) announced the initiation of the ISDA 2015 Section 871(m) Protocol, which responds to recent changes in U.S. tax laws that will impose a 30% withholding tax on a range of equity derivatives transactions entered into from January 1, 2016, involving U.S. equity securities. The Protocol will allow market participants to amend their ISDA Master Agreements to assign the withholding tax to the party taking the long position. ISDA Press Release.

ISDA OTC Derivatives Compliance Calendar

On November 2nd, the ISDA published its updated OTC Derivatives Compliance Calendar, which contains a global calendar of compliance deadlines and other regulatory dates related to over-the-counter derivatives.


SEC Takes Additional Time to Consider NASDAQ’s Proposal to Adopt a New Routing Option

On November 3rd, the SEC gave notice that it will designate a longer period in which to consider The NASDAQ Stock Market LLC’s (“NASDAQ”) proposed rule change to adopt the Retail Order Process, a new routing option. The SEC will either approve or disapprove the proposed rule change, or institute disapproval proceedings, by December 30, 2015. SEC Release No. 34-76335.

National Futures Association

NFA Updates Forex Regulatory Guide

On November 3rd, the National Futures Association (“NFA”) released an updated version of its regulatory guide for Forex transactions. The guide has been revised to include amendments to NFA Compliance Rule 2-36, Financial Requirements Sections 11 and 12, and the newly adopted Interpretive Notice requiring Forex Dealer Members to implement cybersecurity risk management programs. NFA Forex Regulatory Guide.

National Securities Clearing Corp

NSCC Proposes Mechanism for AIP Sub-Account Settlement

On November 4th, the SEC provided notice of the filing of a proposed rule change by the National Securities Clearing Corp. (“NSCC”) to amend its Rules & Procedures regarding the Alternative Investment Product Services (“AIP”). Under the proposal, AIP Administrators would be allowed to create sub-accounts that settle separately from their primary AIP accounts and their other AIP sub-accounts. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015. SEC Release No. 34-76348.


NYSE Seeks to Use Wireless Connection to Provide Third Party Market Feeds

On November 5th, the SEC announced a proposed rule change submitted by the New York Stock Exchange LLC (“NYSE”) that would allow co-located Users to receive market data feeds from third party markets via a wireless connection. The proposal also establishes fees for the use of this service and would amend the NYSE Price List to reflect these new fees. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of November 9, 2015. SEC Release No. 34-76374.

NYSE to Assume Regulatory Responsibilities from FINRA in the New Year

On November 4th, the NYSE distributed an Information Memo notifying its members of the upcoming transfer of certain regulatory responsibilities from FINRA to NYSE Regulation (“NYSER”). Effective January 1, 2016, NYSER will have primary responsibility for monitoring the five NYSE markets for potential non-compliance with NYSE rules and securities laws, conducting regulatory inquiries concerning conduct occurring in the five NYSE markets, and conducting investigations and prosecutions resulting from these inquiries. FINRA will retain responsibility for handling potential misconduct that occurs across multiple venues. NYSE Information Memo 15-6.

SEC Designates Longer Period to Consider NYSE’s Proposed Shareholder Approval Exemption for Early Stage Companies

On October 30th, the SEC gave notice that it has designated December 31, 2015, as the date by which it will either approve or disapprove NYSE’s proposal to exempt early-stage companies from the requirement to obtain shareholder approval before issuing shares for cash to related parties, affiliates of related parties, or entities in which a related party has a substantial interest. SEC Release No. 34-76323.

Industry News

BATS Global Markets Says IEX’s ‘Flash Boys’ Speed Bump Is Unfair

On November 2nd, Reuters reported on Exchange operator BATS Global Markets’ suggestion that regulators require upstart trading venue IEX Group, which was featured in Michael Lewis’s 2014 book “Flash Boys: A Wall Street Revolt,” to amend its application to become a registered stock exchange in order to remove an “unfair and unreasonably discriminatory” aspect. BATS questioned IEX’s use of a “speed bump” that delays incoming orders to its trading platform by 350 millionths of a second, which IEX says allows it to update changing prices before the quickest market participants can act on out-of-date prices, preventing them from jumping ahead in the line.IEX GroupBATS Application Letter.

Firms and Regulators Are Trying to Figure Out What Is Important Enough to Tell Shareholders

On November 2nd, The Wall Street Journal reported on the dilemma that regulators in the U.S. and abroad are facing when it comes to the concept of “materiality,” or how to determine what information is necessary for companies to disclose publicly. At the same time, companies are experiencing a costly and complex sorting process, as what is considered “material” varies from regulator to regulator. Materiality.