Insights from Winston & Strawn

On June 29, 2015, the Securities and Exchange commission (“SEC”) settled an enforcement action against Kohlberg Kravis Roberts & Co., a private equity firm and registered investment adviser (the “Respondent”). The SEC’s order alleged that the Respondent misallocated more than $17 million in so­called “broker deal” expenses to its private equity funds in breach of its fiduciary duty. In settling this matter, the Respondent agreed to pay a $10 million penalty and $18.6 million in disgorgement and interest.

The broken deal expenses included diligence expenses related to unsuccessful buyout opportunities and other similar types of expenses. Respondent allocated broken deal expenses to its main or “flagship” private equity funds on a geographic basis, e.g., broken deal expenses related to North American deals were allocated to a fund that invested primarily in opportunities in North America. While that fund’s limited partnership agreement permitted allocation to it of “all” broken deal expenses “incurred by or on behalf of” the fund, Respondent also invested in affiliated investment vehicles, but did not allocate broken deal expenses to Respondent’s co­ investors. As stated in the order, Respondent failed to expressly disclose in the fund’s limited partnership agreement that it did not allocate broken deal expenses to Respondent’s co­investors, even though these co­ investors participated in and benefited from Respondents sourcing of private equity transactions.

The order found that, absent such disclosure, Respondent’s misallocated $17.4 million in broken deal expenses in violation of its fiduciary duty to the fund and in violation of Section 206(2) of the Advisers Act of 1940, as amended (the “Act”), which prohibits an investment adviser from engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.”

The order also found that Respondent failed to adopt and implement written policies and procedures governing its broken deal expense allocation practice until 2011, notwithstanding that it registered with the SEC as an investment adviser in October 2008. This failure violated Section 206(4) of the Act and Rule 206(4)­7, which requires registered investment advisers to adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Act and its rules.

Focus on Private Equity Funds

While the SEC’s case represents the first time the SEC has charged a private equity adviser with misallocating broken deal expenses, it also reflects the SEC’s continued scrutiny of fees and expenses charged by private equity firms. Indeed, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), in its Examination Priorities for 2015, identified fees and expenses of private equity funds as one of its examination priorities for 2015. The SEC’s press release relating to the above action also identified the SEC Enforcement Division’s Asset Management Unit as scrutinizing the private equity industry “to make sure that fund managers aren’t misallocating or unfairly charging fees and expenses to investors.”

Takeaways for Private Equity Funds

To the extent they have not already done so, private equity firms should identify the fees and expenses they charge their client funds and confirm whether such fees and expenses are fairly and fully disclosed to clients in a manner that is designed to put clients on notice both as to the fees and expenses that they may bear and the method of allocation of those expenses among and between clients and proprietary and affiliated accounts. Again, if they have not already done so, private equity firms should also reevaluate their disclosure and expense allocation policies and procedures, with focus on (i) the ability to document expenses and fees and their allocation and (ii) on whether the policies and procedures are consistent with a standard of fair and full disclosure as contemplated by the SEC’s order referenced above.

Glen P. Barrentine

Feature: Liquidity Funds

The Treasury Department’s Office of Financial Research (“OFR”) published a paper entitled “Private Fund Data Shed Light on Liquidity Funds.” The paper analyzes for the first time the data collected by the Securities and Exchange Commission (“SEC”) on Form PF concerning liquidity funds, which are private funds that seek to generate income by investing in a portfolio of short­term obligations in order to maintain a stable net asset value or minimize principal volatility.

Form PF first quarter data showed that filers managed $288 billion in liquidity funds and an additional $359 billion in parallel managed accounts. When compared with those of prime money market funds, liquidity funds hold assets with relatively longer maturities, have larger holdings of Treasury securities, and invest in a broader range of asset classes.

OFR found that about 95% of liquidity fund assets are classified as Level 2 for fair value measurement while less than 0.01% of total assets are classified as Level 3. That focus on Level 2 assets is comparable to prime money market funds. Liquidity funds also have relatively low leverage levels. Only four funds had leverage levels higher than 1.05 times, measured as the ratio of the gross asset value of a fund to its net asset value, and derivative positions accounted for a negligible percentage of fund assets.

Taken as a whole, the paper found that even though liquidity funds are not required to abide by the same rules as mutual funds marketed to retail investors, the liquidity transformation risks in liquidity funds generally do not appear to be significantly different from prime money market funds, although an individual liquidity fund may exhibit greater liquidity transformation risks than the average prime money market fund. these risks are tempered, however, by relatively large liquid asset holdings and the ability of most liquidity funds to suspend redemptions or impose redemption gates. The fact that many short­term investments are held in parallel managed accounts also reduces redemption risks because there are no first­mover advantages. View the paper here.

FINRA – Regulatory Matters at a Glance

Please click here to view a summary of the regulatory notices, rule filings, guidance and the like published by the Financial Industry Regulatory Authority (“FINRA”) during the previous month.

Banking Agency Developments

FDIC Advisory Committee on Community Banking to Meet

The Federal Deposit Insurance Corporation’s (“FDIC”) Advisory Committee on Community Banking will meet on July 10, 2015. FDIC staff will provide an update on the FDIC's Community Banking Initiatives and discuss a number of issues, including examination frequency and offsite monitoring; call report streamlining; the cybersecurity assessment tool; and recent rulemakings. There also will be discussions about high volatility commercial real estate loans and the review of banking regulations under the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (“EGRPRA”). FDIC Press Release.

OCC Mutual Savings Association Advisory Committee to Meet

The Office of the Comptroller of the Currency’s (“OCC”) Mutual Savings Association Advisory Committee will meet on July 22, 2015. Written statements should be submitted on or before July 15, 2015. OCC Press Release

Banking Agencies to Hold EGRPRA Outreach Meeting

The federal banking agencies will hold an outreach meeting on August 4, 2015, at the Federal Reserve Bank of Kansas City as part of their regulatory review under the EGRPRA. The meeting will focus on rural banking issues and will feature panel presentations by industry participants and consumer and community groups. Joint Agency Press Release.

List of Distressed or Underserved Nonmetropolitan Middle­Income Geographies

On July 8th, the Federal Reserve Board (“FRB”), OCC, and FDIC announced the availability of the 2015 list of distressed or underserved nonmetropolitan middle­income geographies, where revitalization or stabilization activities will receive Community Reinvestment Act consideration as community development. Joint Agency Press Release.

Public Portions of Resolution Plans Posted

On July 6th, the FRB and FDIC posted the public portions of annual resolution plans for 12 large financial firms. Each plan describes the company's strategy for rapid and orderly resolution under the U.S. Bankruptcy Code in the event of material financial distress or failure of the company. Joint Agency Press Release.

Trillion Dollar Limit

On July 1st, the FRB released its first determination of the aggregate consolidated liabilities of all financial companies as required by Section 622 of the Dodd­Frank Act, which prohibits any financial company from combining with another company if the resulting company's liabilities exceed 10% of the aggregate consolidated liabilities of all financial companies. As of December 31, 2014, aggregate financial sector liabilities was equal to $21,632,232,035,000. This number will be the measure of aggregate consolidated liabilities for the purposes of Section 622 of the Dodd­Frank Act from July 1, 2015 through June 30, 2016. FRB Press Release.

FFIEC Cybersecurity Assessment Tool

On June 30th, the OCC issued a Bulletin on the Federal Financial Institutions Examination Council’s Cybersecurity Assessment Tool. The Assessment can be used by institutions to evaluate their risks and cybersecurity preparedness. OCC examiners will gradually incorporate the Assessment into their examinations. OCC Bulletin.

Semiannual Risk Perspective

On June 30th, the OCC published its Semiannual Risk Perspective for Spring 2015. Interest rates, underwriting, compliance, and cybersecurity top the OCC’s supervisory concerns. The report also noted declining revenues and profitability overall in OCC­supervised institutions. OCC Press Release.

Agencies Issue Host State Loan­to­Deposit Ratios

On June 29th, the FRB, FDIC, and OCC issued the host state loan­to­deposit ratios that they will use to determine compliance with Section 109 of the Riegle­Neal Interstate Banking and Branching Efficiency Act of 1994. Joint Agency Press Release.

OCC Quarterly Report on Bank Trading and Derivatives Activities

On June 29th, the OCC issued its Quarterly Report on Bank Trading and Derivatives Activities. Among other things, the report noted that insured U.S. commercial banks and savings institutions reported trading revenue of $7.7 billion in the first quarter of 2015, $3.2 billion higher (72%) than in the fourth quarter. Trading revenue in the first quarter was $1.5 billion higher (24%) than in the first quarter of 2014. However, although recent trading results are positive, the long­term outlook for trading revenue is still uncertain. OCC Press Release.

Treasury Department Developments

CFPB Principles for Payment Systems

On July 9th, the Consumer Financial Protection Bureau (“CFPB”) outlined guiding principles for protecting consumers as new faster payment systems are developed. The CFPB wants to ensure that any new payment system is secure, transparent, accessible, and affordable to consumers. The systems should also have robust protections when it comes to fraud and error resolution. CFPB Press Release.

Securities and Exchange Commission

New Final Rules

Freedom of Information Act Regulations

On July 8th, the SEC published the adopting release and text of new, final rules promulgated under the Freedom of Information Act. The new rules permit the Commission to collect fees that reflect its actual costs, add an appeals time frame that will create a more practical and systematic administrative process, and clarify other issues in the regulations. The new rules are effective 30 days after publication in the Federal Register, which is expected during the week of July 13. SEC Release No. 34­75388.

Proposed Rules and Requests for Comment

Listing Standards for Erroneously Awarded Compensation

On July 1st, the SEC published for comment proposed rules that would prohibit the listing of any security of an issuer that is not in compliance with Securities Exchange Act Section 10D’s requirements for disclosure of the issuer’s policy on incentive­based compensation and recovery of incentive­based compensation that is received in excess of what would have been received under an accounting restatement. The proposed rule and rule amendments would direct the national securities exchanges and national securities associations to establish listing standards that would require each issuer to develop and implement a policy providing for the recovery, under certain circumstances, of incentive­based compensation based on financial information required to be reported under the securities laws that is received by current or former executive officers, and require the disclosure of the policy. A listed issuer would be required to file the policy as an exhibit to its annual report. Comments should be submitted within 60 days after publication in the Federal Register, which is expected shortly. SEC Release No. 33­9861; SEC Press Release. Commissioners Daniel M. Gallagher and Michael S. Piwowar dissented from the publication of the proposal. Gallagher objected to the proposed amendments’ broad definition of executive officers who could be subject to the clawback requirement; the inclusion of small, emerging, and foreign issuers; and the manner in which the amount to be clawbacked is calculated. Gallagher Statement. Similarly, Piwowar criticized the proposal’s broad approach and noted a possible unintended consequence: the proposal’s “no fault” provision, which requires executives to repay incentive­based compensation even if they played no role in the financial misstatement. That provision could cause executives to seek an increase in their fixed compensation. Piwowar Statement.

Audit Committee Disclosures

On July 1st, the SEC published for comment a concept release on audit committee disclosure requirements, focusing on the committee’s oversight of independent auditors. The Commission seeks information about the audit committee and auditor relationship and whether improvements can be made to enhance the information provided to investors about the audit committee’s responsibilities and activities. The concept release also invites comment on whether Commission disclosure requirements should be refined to provide more insight into the information the audit committee used and the factors it considered in overseeing the independent auditor. Comments should be submitted on or before September 8, 2015. SEC Release No. 33­9862; SEC Press Release.


Investment Management Guidance on Personal Securities Transaction Reporting Rule

On June 26th, the Division of Investment Management provided guidance on Investment Advisers Act Rule 204A­1, which generally requires an adviser’s Code of Ethics to include requirements that advisory personnel with access to nonpublic information regarding securities transactions report personal securities trading. The guidance addresses Rule 204A­1’s exception to the reporting requirement for access persons who hold securities in accounts over which they have “no direct or indirect influence or control.” The guidance makes clear that simply granting a third party with management authority over an account or providing a third­party manager with discretionary authority is insufficient for an adviser to reasonably believe that the access person has no direct or indirect influence or control over the account for purposes of relying on the reporting exception.

Exemptive Relief

Closed­End Fund May Make Regular Distributions

On July 7th, the Division of Investment Management granted an exemptive order permitting certain registered closed­end investment companies to make periodic distributions of long­term capital gains with respect to their outstanding common stock as frequently as twelve times in any one taxable year, and as frequently as distributions are specified by or in accordance with the terms of any outstanding preferred stock that such investment companies may issue. Exemptive Order.

ETF’s May Include Long/Short Indexes

On June 24th, the Division of Investment Management granted SPDR Series Trust and SPDR Index Shares Funds (the “Trusts”), which are each operated as exchange­traded funds, request for no­action relief if the Trusts’ definition of “Index” includes “Long/Short Indexes.” No­Action Letter.

Statements and Speeches

Commissioner Aguilar’s Statement of Support for CCOs

On June 29th, SEC Commissioner Luis A. Aguilar issued a statement assuring compliance personnel that the agency is not singling them out as enforcement targets. Aguilar made his statement in response to Commissioner Daniel M. Gallagher’s June 18, 2015 dissent from two enforcement actions against the Chief Compliance Officers (“CCO”) of two different investment advisers. See Gallagher Statement. Aguilar’s statement emphasized how infrequently the SEC files enforcement actions against CCOs and how most of those cases against CCOs involved those who also engaged in the business activities of the adviser. Aguilar further noted how the agency recently brought an enforcement action against an adviser which failed to provide its CCO with adequate resources. See In the Matter of Pekins Singer Strauss Asset Management Inc., SEC Release No. IA­ 4126.

Other Developments

Advisory Committee on Small and Emerging Companies to Meet

The SEC’s Advisory Committee on Small and Emerging Companies will hold a public meeting by telephone conference on July 15, 2015. The advisory committee plans to continue its discussions regarding public company disclosure effectiveness and the regulatory treatment of so­called “finders” that assist companies in capital raising activities. SEC Press Release.

Senate Bill Would Raise SEC Penalty Cap

On July 9th, Senators Charles Grassley and Jack Reed introduced the Stronger Enforcement of Civil Penalties Act (“SEC Penalties Act”) of 2015, which would raise the statutory limits on civil monetary penalties the SEC may impose. The bill would directly link the size of SEC administrative civil penalties to the scope of harm and associated investor loss, and additionally raise the financial penalties which could be imposed against recidivists. Under the proposed bill, the per­violation cap would increase to $1 million per violation for individuals, and $10 million per violation for entities. The penalty cap for recidivists would triple. Grassley Press Release.

Trading in Privately Owned Companies

On July 6th, Market Watch, reported that the SEC is investigating the recent increase in trading activity involving shares of privately owned companies. SEC Probe.

Draft EDGAR Manuals Published

On July 2nd, the SEC published Draft EDGAR Filer Manual (Volume II) EDGAR Filing (Version 33); Draft EDGAR Filer Manual (Volume I) General Information (Version 22); and Draft EDGARLink Online XML Technical Specification (Version 17).

Four­Step Program for Cybersecurity

On July 1st, Forbes outlined four steps investment advisers should follow to implement the Division of Investment Management’s guidelines for cybersecurity. Four­Step Program.

Office of the Investor Advocate Issues Report and Warning

On June 30th, the SEC’s Office of the Investor Advocate published its semi­annual report to Congress. This year, the Office is primarily focused on six core policy areas: investor flight, elder fraud, cybersecurity, equity market structure, municipal market reforms, and ways to improve the effectiveness of disclosure. Investor News noted the report’s comments concerning a harmonized fiduciary duty rule for broker­dealers and investment advisers. The Investor Advocate cautioned that a harmonized rule could weaken existing protections for investment advisory clients and warned that he would oppose any proposal that might weaken investor protections. Warning.

Administrative Actions

On June 28th, the New York Times reviewed the arguments made by those objecting to the SEC’s use of administrative proceedings to bring complex and sometimes novel enforcement cases and explained some of the ideas suggested to answer those objections. Administrative Actions.

Universal Proxies

On June 26th, summarized the reaction to SEC Chair Mary Jo White’s recent comments regarding the development of universal proxy rules for shareholder voting. Split Response.

Commodity Futures Trading Commission

Registration Exemption Based on Substituted Compliance Sought

On July 9th, the Commodity Futures Trading Commission (“CFTC”) requested public comment on a petition by OTC Clearing Hong Kong Limited for exemption from registration as a derivatives clearing organization (“DCO”) under Section 5b(h) of the Commodity Exchange Act, which permits the CFTC to exempt a clearing organization from DCO registration for the clearing of swaps to the extent that the CFTC determines that such clearing organization is subject to comparable, comprehensive supervision by appropriate government authorities in the clearing organization’s home country. Comments should be submitted on or before July 23, 2015. CFTC Press Release.

Proposed Increase in Position Limits is Stayed

On July 7th, the CFTC announced it has stayed ICE Futures U.S. Inc.’s amendments to Resolution No. 2 of Chapter 18 of its rulebook. The amendments would increase position limits, single month accountability levels, and all month accountability levels for eight financial power futures. The CFTC’s Division of Market Oversight issued the stay because the submission in support of the amendment contains an inadequate explanation of the subject rule amendment and is potentially inconsistent with the Commodity Exchange Act. Comments on the amendment should be submitted on or before August 6, 2015. CFTC Press Release.

Margin Requirements for Uncleared, Cross­Border Swaps Proposed

On June 29th, the CFTC voted unanimously to propose a rule that would apply the agency’s margin requirements for uncleared swaps to cross­border transactions. The proposed rule would apply to CFTC­ registered swap dealers and major swap participants that are not subject to the margin requirements of other prudential regulators. The proposal permits substituted compliance with respect to margin that covered firms post (but not that they collect) for swaps with certain non­U.S. counterparties. In addition, under the proposed rule: uncleared swaps of non­U.S. covered swap entities whose obligations under the relevant swap are guaranteed by a U.S. person would be treated the same as uncleared swaps of U.S. covered swap entities; uncleared swaps of non­U.S. covered swap entities whose obligations under the relevant swap are not guaranteed by a U.S. person would be eligible for substituted compliance unless the counterparty to the swap is a U.S. covered swap entity or a non­U.S. covered swap entity whose obligations under the swap are guaranteed by a U.S. person; and uncleared swaps between a non­U.S. covered swap entity and a non­U.S. counterparty would be excluded from the margin rules if neither party’s obligations under the relevant swap are guaranteed by a U.S. person and neither party is a U.S. branch of a non­U.S. covered swap entity nor consolidated in the financial statements of a U.S. person. Comments should be submitted within 60 days after publication in the Federal Register. CFTC Fact Sheet.

Federal Rules Effective Dates

July 2015 ­ September 2015

Commodity Futures Trading Commission

July 10, 2015             Proceedings Before the Commodity Futures Trading Commission; Rules Relating to Suspension or Disbarment From Appearance and Practice. 80 FR 32855.

Consumer Financial Protection Bureau

August 31, 2015         Defining Larger Participants of the Automobile Financing Market and Defining Certain Automobile Leasing Activity as a Financial Product or Service. 80 FR 37495.

August 10, 2015         Minimum Requirements for Appraisal Management Companies. 80 FR 32657.

August 1, 2015           Amendments to the 2013 Integrated Mortgage Disclosures Rule Under the Real Estate Settlement Procedures Act (Regulation X) and the Truth In Lending Act (Regulation Z) and the 2013 Loan Originator Rule Under the Truth in Lending

                                      Act (Regulation Z). 80 FR 8767.

Integrated Mortgage Disclosures Under the Real Estate Settlement Procedures Act (Regulation X) and the Truth In Lending Act (Regulation Z). 78 FR 79730.

Federal Deposit Insurance Corporation

August 10, 2015         Minimum Requirements for Appraisal Management Companies. 80 FR 32657.

July 23, 2015             Regulation D: Reserve Requirements for Depository Institutions. 80 FR 35565.

July 1, 2015               Restrictions on Sale of Assets of a Failed Institution by the Federal Deposit Insurance Corporation. 80 FR 22886.

Federal Housing Finance Agency

August 10, 2015         Minimum Requirements for Appraisal Management Companies. 80 FR 32657.

July 6, 2015               Minority and Women Inclusion Amendments. 80 FR 25209.

Federal Reserve System

August 10, 2015         Minimum Requirements for Appraisal Management Companies. 80 FR 32657.

July 23, 2015             Regulation D: Reserve Requirements for Depository Institutions. 80 FR 35565.

National Credit Union Administration

July 6, 2015               Chartering and Field of Membership Manual. 80 FR 25924.

Office of the Comptroller of the Currency

August 10, 2015         Minimum Requirements for Appraisal Management Companies. 80 FR 32657.

July 1, 2015               Integration of National Bank and Federal Savings Association Regulations: Licensing Rules. 80 FR 28345.

Office of Foreign Assets Control

July 10, 2015             Venezuela Sanctions Regulations. 80 FR 39676.

Exchanges and Self­Regulatory Organizations

Chicago Board Options Exchange

Longer Period Designated for Consideration of Hybrid System Complex Order Proposal

On July 6th, the SEC designated August 25, 2015 as the date by which it will approve, disapprove, or institute disapproval proceedings regarding the Chicago Board Options Exchange’s (“CBOE”) proposed rule change to modify Rule 6.53C, Complex Orders on the Hybrid System, to give the Exchange the flexibility to distinguish between Professional and non­Professional orders for the purposes of determining eligibility for COA. SEC Release No. 34­75359.

Proposed Changes to Trading Permit Holder Rules Approved

On June 26th, the SEC approved the CBOE’s proposed rule changes to adopt new Rule 3.4A (Additional Trading Permit Holder Qualifications) to (i) add additional qualification requirements for persons seeking to become and remain Trading Permit Holders, (ii) add a requirement regarding access by Sponsored Users in CBOE Rule 6.20A (Sponsored Users), (iii) add a requirement regarding access to the System in CBOE Rule 6.23A (Trading Permit Holder Connectivity), and (iv) make non­substantive changes to renumber the paragraphs in CBOE Rule 3.4 (Foreign Trading Permit Holders). SEC Release No. 34­75317.

Proposed Floor Broker Due Diligence Amendments Approved

On June 25th, the SEC approved the CBOE’s proposed amendments to its rules to address certain order handling obligations on the part of its Floor Brokers. SEC Release No. 34­75299.

Chicago Stock Exchange

Intra­Day, On­Demand Auction Service Proposed

On July 1st, the SEC provided notice of the Chicago Stock Exchange’s filing of proposed amendments and new rules that would implement CHX SNAP (Subsecond Non­displayed Auction Process), an intra­day and on­ demand auction service that could occur numerous times throughout a regular trading session at the request of participants seeking to trade securities in bulk. SNAP Cycles are designed to transition seamlessly from, and back to, automated trading in the subject security, and to occur simultaneously with automated trading in the subject security elsewhere in the national market system. SNAP is designed to address a specific market need for bulk trading of securities on an exchange, which will operate efficiently within the national market system. Comments should be submitted on or before July 29, 2015. SEC Release No. 34­75346.

The Depository Trust Company

End­of­Day Acknowledgement Proposal Withdrawn

On July 7th, the SEC provided notice of The Depository Trust Company’s withdrawal of a proposed rule change regarding the acknowledgment of End­of­Day Net­Net Settlement Balances by Settling Banks. SEC Release No. 34­75380.

Financial Industry Regulatory Authority

Securities Trader and Securities Trader Principal Registration Categories Proposed

On July 8th, the SEC provided notice of the Financial Industry Regulatory Authority’s (“FINRA”) filing of a proposed amendment to NASD Rule 1032(f) (Limited Representative­Equity Trader) to replace the Equity Trader registration category and qualification examination (Series 55) with a Securities Trader registration category and qualification examination (Series 57). In addition, the proposed rule change would amend NASD Rule 1022(a) (General Securities Principal) to establish a Securities Trader Principal registration category. The proposal also makes technical conforming changes to the Form U4 (Uniform Application for Securities Industry Registration or Transfer). Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of July 13. SEC Release No. 34­75394.

BrokerCheck Proposal Submitted

On July 7th, the SEC provided notice of FINRA’s filing of a proposed amendment to FINRA Rule 2210 that would require each of a member’s websites to include a readily apparent reference and hyperlink to BrokerCheck on: (i) the initial webpage that the member intends to be viewed by retail investors; and (ii) any other webpage that includes a professional profile of one or more registered persons who conduct business with retail investors. These requirements would not apply to a member that does not provide products or services to retail investors, or to a directory or list of registered persons limited to names and contact information. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of July 13. SEC Release No. 34­75377.

Expansion of ATS Transparency Initiative Proposed

On July 2nd, the SEC provided notice of FINRA’s filing of a proposal that would expand FINRA’s alternative trading system (“ATS”) transparency initiative to publish the remaining equity volume executed over­the­counter (“OTC”) by FINRA members, including, among other trading activity, non­ATS electronic trading systems and internalized trades. Comments should be submitted on or before July 30, 2015. SEC Release No. 34­75356.

Amendments to Rules Governing Cease­and­Desist Orders Proposed

On June 30th, the SEC provided notice of FINRA’s filing of proposed amendments to FINRA Rule Series 9100, 9200, 9300, 9550, and 9800 to modify the evidentiary standard that must be met to impose a temporary cease and desist order, to adopt a new expedited proceeding for repeated failures to comply with temporary or permanent cease and desist orders, to ease administrative burdens in temporary cease and desist proceedings, to harmonize the provisions governing how documents are served in temporary cease and desist proceedings and expedited proceedings, to clarify the process for issuing permanent cease and desist orders, and to make conforming changes throughout FINRA’s Code of Procedure. Comments should be submitted on or before July 28, 2015. SEC Release No. 34­75333.

FINRA Advises of SEC Updates to Financial Responsibility Rule Interpretations.

On June 29th, FINRA announced the availability of updates to interpretations in the Interpretations of Financial and Operational Rules that have been communicated to FINRA by the staff of the SEC’s Division of Trading and Markets. The updated interpretations relate to the effectiveness of amendments that the SEC adopted to Securities Exchange Act Rules 15c3­1 and 15c3­3. FINRA Regulatory Notice 15­25.

International Swaps and Derivatives Association

ISDA Single­Name CDS Roll Recommendation

On July 8th, the International Swaps and Derivatives Association published a recommendation for an amendment to the single­name credit default swap (“CDS”) roll frequency. Under the new recommended standard schedule, single­name CDS transactions would roll to a new “on­the­run” contract on a semiannual, rather than quarterly, basis. The move would further align single­name CDS contracts with CDS index trades. ISDA Press Release.


Proposed Electronic Solicitation Mechanism is Disapproved

Solicitation Mechanism that would have introduced a new electronic solicitation mechanism pursuant to which a member could have electronically submitted all­or­none orders of 500 contracts or more (or, in the case of mini options, 5000 contracts or more) that the member represented as agent against contra orders that the member solicited. SEC Release No. 34­75300.

National Futures Association

Changes to CPO Form PQR and CTA Form PR

On July 8th, the National Futures Association announced it has made changes to the CPO Form PQR and CTA Form PR effective for the quarter ending June 30, 2015. NFA Notice I­15­16.


Revisions to Price List Proposed

On July 2nd, the SEC provided notice of the New York Stock Exchange’s filing of proposed amendments to its price list to revise: (i) the non­tier adding credit; (ii) certain fees for executions at the close; (iii) credits applicable to designated market makers; (iv) credits applicable to supplemental liquidity providers; and (v) pricing related to the retail liquidity program under Rule 107c as it relates to designated market maker transactions, and to make non­substantive changes to the price list. Comments should be submitted on or before July 30, 2015. SEC Release No. 34­75353.

Modifications to Appointment Process Approved

On June 29th, the SEC approved NYSE MKT’s and NYSE Arca’s separately proposed amendment of their respective rules to modify each of their processes for the appointment and withdrawal of options Market Makers. Under the amendments, once a trading permit holder has been approved as a Market Maker, the Market Maker would, subject to certain conditions, be permitted to register rather than apply for an appointment in one or more option classes, and would be permitted to select or withdraw option issues included in its appointment using an exchange­approved electronic interface. The exchange will also include a Market Maker’s available financial resources and operational capability as considerations in its periodic evaluation of Market Maker performance, which factors currently are considered when a Market Maker applies for an appointment.

Judicial Developments

Loose Deadlines

On July 10th, the D.C. Circuit held that the SEC may bring an administrative enforcement action even though it is instituted more than 180 days after the respondent received notice of the investigation from the Enforcement Division. Petitioners, registered investment advisers to institutional investors, argued that an enforcement action against them was untimely under Section 4E of the Securities Exchange Act, which contains the 180­day deadline, and must therefore be dismissed. Denying the petition, the Court found that the SEC’s interpretation of Section 4E as not imposing a jurisdictional bar is reasonable and entitled to deference. Montford and Co. Inc. v. SEC.

Shareholder Proposal Fails to Transcend Ordinary Business Exception

On July 6th, the Third Circuit reversed a district court opinion that found that a shareholder proposal introduced by Trinity Wall Street could not be excluded from Wal­Mart’s proxy under SEC Rule 14a­8's “ordinary business exception.” The Third Circuit held that the proposal, which sought to require a Wal­Mart board committee to establish policies on whether Wal­Mart should sell products that endanger the public safety or are offensive, does not transcend Wal­Mart’s ordinary business operations. Trinity Wall Street v. Wal­Mart Stores Inc.

Ninth Circuit’s Tip to Insider Trading Prosecutions

On July 6th, the Ninth Circuit affirmed Bassam Yacoub Salman’s insider trading conviction. Salman, a downstream tippee, argued that the evidence failed to support his conviction because the government failed to show that, in accordance with U.S. v. Newman, Salman knew that the information he received was disclosed by a tipper who violated a fiduciary duty and received a personal benefit in return. Rejecting that argument the Ninth Circuit held that the direct evidence that the disclosure was intended as a gift was sufficient. No additional tangible benefit was required. US v. Salman.

Indiana Law Allows a Corporation to Vote Its Own Shares

On July 2nd, the Seventh Circuit affirmed a district court opinion that allowed Emmis Communications to engage in a series of transactions to retire its preferred shares. Holders of the preferred shares challenged the transactions, arguing that Emmis violated Indiana law by voting some shares. Although Indiana allows corporations to vote their own shares, plaintiffs claimed corporations can only vote “outstanding” shares. Here, however, the shares were held in escrow pending a “swap” and were, therefore, no longer “outstanding.” The Seventh Circuit held that Indiana law gives voting rights to record owners and those involved in the swap were the record owners. Corre Opportunities Fund LP v. Emmis Communications Corp.

Exclusivity Claims Protected by PSLRA’s Safe Harbor

On July 2nd, the Eighth Circuit affirmed a district court's order dismissing a class action securities fraud lawsuit. Plaintiffs who purchased or otherwise acquired shares of K­V Pharmaceutical Company stock while K­V was launching and marketing a new prescription drug alleged that K­V made materially false or misleading statements when it said that it anticipated that the Food and Drug Administration would enforce exclusivity after the launch. The Eighth Circuit agreed with the district court that K­V's statements fell within the safe­harbor provision of the Private Securities Litigation Reform Act of 1995 as forward­looking statements. Julianello v. K­V Pharmaceutical Company.

Supreme Court to Hear Regulation SHO Case

On June 30th, the U.S. Supreme Court granted a petition for certiorari seeking review of a Third Circuit opinion ordering that a suit alleging that petitioners engaged in abusive naked short­selling be remanded to state court. Shareholders in Escala Group, Inc. allege that various financial institutions involved in equities trading engaged in naked short selling of Escala stock in violation of state law. Citing plaintiffs' references to the SEC's Regulation SHO, defendants removed the suit to federal court. On interlocutory appeal the Third Circuit found that Regulation SHO is not an element of plaintiffs' claims. Plaintiffs, the circuit court found, can prevail on their state law claims without any need to prove or establish a violation of federal law. The Supreme Court granted certiorari to consider “Whether § 27 of the Securities Exchange Act of 1934 provides federal jurisdiction over state­law claims seeking to establish liability based on violations of the Act or its regulations or seeking to enforce duties created by the Act or its regulations.” Merrill Lynch v. Manning.

Repo Clients Aren’t Customers under SIPA

On June 29th, the Second Circuit held that an investor who delivered securities to a broker­dealer as part of a repurchase agreement is not protected by the Securities Investor Protection Act because the investor did not entrust assets to the broker­dealer. In the Matter of Lehman Brothers Inc.

Industry News

Risk Retention Compliance

On July 9th, Institutional Investor considered the different paths managers of collateralized loan obligations may take as they consider how to comply with risk retention rules that will be effective next year. Risk Retention.

IRS Revises Treatment of Basket Options

On July 8th, DealBook summarized new Internal Revenue Service guidelines on the treatment of basket options. Under the new guidelines, basket options will be treated as listed transactions to be declared on tax returns. The guidance is retroactive to January 1, 2011. Basket Options.

Margin Hub

On July 7th, Reuters discussed industry plans for the formation of a centralized processing platform for the posting of margin for over­the­counter swap transactions. Margin Hub.

IMF Assessment of U.S. Regulatory Reforms

On July 7th, the International Monetary Fund (“IMF”) published its five­year assessment of the U.S. financial sector. The assessment recognizes the steps U.S. regulators have taken to implement financial reforms but cautions that more should be done. Unaddressed areas include money market funds, securities lending, and the tri­party repo markets. IMF Press Release.

Balancing Act

On July 7th, University of California, Berkeley, law professor Steven Davidoff Solomon, writing for DealBook, reviewed recent efforts by federal regulators to reduce risk in the leveraged loan market and the consequences of those efforts. Balancing Act.

Not So Shadowy

On July 2nd, Bloomberg noted the role played by traditional banks, Fannie Mae, and Freddie Mac in the growth of the so­called “shadow bank” industry. Out of the Shadows.

The Fix

On June 28th, Bloomberg reported the New York Department of Financial Services is investigating the International Swaps and Derivatives Associate Fix (“ISDAfix”) benchmark, which is used to value interest rate swaps, for possible manipulation. The Fix.