Insights from Winston & Strawn

On April 7th, the Securities and Exchange Commission (“SEC”) approved the Financial Industry Regulatory Authority’s (“FINRA”) proposed amendment to NASD Rule 1032(f) that would require algorithmic trading developers to register as Securities Traders. Under the approved rule, associated persons of trading firms who are “primarily responsible for the design, development or significant modification of algorithmic trading strategies, or who are responsible for the day-to-day supervision or direction of these activities,” will have to pass a qualification exam, register as a Securities Trader, and adhere to continuing education requirements applicable to Securities Traders. FINRA member firms will be required to designate a principal to be responsible for supervising algorithmic trading strategy activities.

The approved rule is part of a series of FINRA initiatives aimed at addressing the explosion of automated trading activities, and the use of such trading algorithms to manipulate markets, through increased transparency and qualification requirements. FINRA has advocated that improved education regarding securities regulations for certain individuals involved in the algorithm design and development process could reduce or prevent problematic conduct stemming from algorithmic trading, such as inaccurate orders, inappropriate levels of messaging traffic, wash sales, and inadequate risk management controls. The proposed rule was first submitted in February 2015 and met with mixed reviews. FINRA submitted a slightly amended version in February 2016, stating it had sought to focus the rule’s scope in an effort to balance those concerns with the goal of ensuring compliance with investor protection rules.

FINRA defines an “algorithmic trading strategy” as an automated system that generates or routes orders or order-related messages—such as routes or cancellations—but does not include an automated system that solely routes orders received in their entirety to a market center. The definition does not include an algorithm that solely generates trading ideas or investment allocations (including an automated investment service that constructs portfolio recommendations) but that is not equipped to automatically generate orders and order-related messages to effectuate such trading. FINRA has provided a list of examples of algorithmic trading strategies and, as the SEC noted in the approval order, the definition could evolve in the future.

Where a firm engages a third party to build an algorithmic trading strategy, the associated person responsible for directing the third party in designing and developing the algorithmic trading strategy would be required to register. Likewise, where a firm purchases an algorithm off-the-shelf, the associated person responsible for monitoring or reviewing the performance of the algorithm would be required to register. Registration will not be required of (i) junior developers or others who solely write code to implement design or modification instructions, and (ii) supervisors not involved in day-to-day supervision of the development process. In the approval order, the SEC stated that it expects FINRA to provide more detailed guidance on implementing the registration requirement.

Although the approved rule only applies to FINRA member firms, the SEC has proposed amendments to Rule 15b9-1 under the Securities Exchange Act of 1934 which would require previously exempt proprietary trading firms to register with FINRA. Additionally, the CFTC has proposed a comprehensive set of regulations governing automated and algorithmic trading (known as “Regulation AT”). As proposed, Regulation AT generally requires (i) implementation of pre-trade risk controls, (ii) development, testing, and monitoring of algorithmic trading systems according to established procedures, and (iii) submission of annual compliance reports and other materials to U.S. designated contract markets. Regulation AT has received a great deal of industry criticism for being overly broad, violating due process, and threatening to destroy the confidentiality of source code.

FINRA will announce the effective date of the approved rule in a Regulatory Notice to be published within 60 days of the SEC’s approval.

Feature: Recent Anti-Money Laundering Developments

Last week, news stories discussing information collected from the millions of files leaked from a Panama law firm, which revealed the offshore accounts of hundreds of politicians and public officials from around the world, dominated the headlines.  The documents, known as the Panama Papers, have also thrust anti-money laundering (“AML”) compliance back into the spotlight.  According to a report in Think Advisor, the Panama Papers have prompted nine advocacy groups, including the progressive nonprofit Americans for Financial Reform, to place renewed pressure on the U.S. Department of the Treasury to finalize its proposal to require investment advisers to comply with AML and suspicious activity reporting obligations. The Financial Crimes Enforcement Network (“FinCEN”), which proposed the rule last August, has indicated that it is in the process of reviewing the comments it received on the proposal and drafting a final rule. According to the article, investment advisers have objected to the rule as overly broad and based on a fundamental misunderstanding of the AML risks posed by investment advisers.

While the storm surrounding the Panama Papers highlights a familiar tale of tax evasion and money laundering set in exotic locales, the story also draws attention to the U.S.’s status as a tax haven and its resistance to international standards for disclosing the bank account information for non-U.S. customers to tax authorities. According to an article in Bloomberg, the U.S. has refused to agree to the standards set out by the Organization for Economic Cooperation and Development (“OECD”); as a result, advisers rely on U.S. resistance to the standards to attract international customers to establish accounts in “U.S. state-level tax and secrecy havens,” including Nevada and South Dakota. While other countries, including Panama, have also been reluctant to agree to the OECD’s standards, the article notes that the U.S. can use its political position to evade international pressure to comply with such regulations.

The fallout from the Panama Papers will almost certainly prompt regulators to redouble their efforts to tighten regulations and enforce compliance. In fact, Reuters reported on April 6th that the U.S. Treasury plans to move ahead with a rule that would require banks to obtain information from their customers regarding the beneficial owners of their accounts in the wake of the scandal.  However, some of these efforts on the part of regulators may result in unintended consequences. The Wall Street Journal recently reported on the implications of Bank Secrecy Act (“BSA”) compliance on enforcement efforts. The Wall Street Journal’s report profiles the U.S. government’s efforts to combat terrorism financing through suspicious activity reports and other BSA flings by banks and financial institutions, which have increased dramatically since the passage of the Patriot Act of 2001. However, in their efforts to comply with BSA requirements and avoid steep penalties, many U.S. banks have closed the accounts of individuals or organizations perceived to be high-risk, suspicious, or difficult to track. After exiting the financial system, these customers move their funds underground and out of reach of the U.S. government’s efforts to track them.  The increasing practice of banks to terminate relationships with suspicious customers, known as “de-risking,” prompted Thomas Curry, head of the Office of the Comptroller of the Currency (“OCC”), to announce that the agency is gathering data on banks’ risk evaluation processes in an effort to determine whether the OCC should issue regulatory guidance to address banks’ concerns, according to a separate report in the Wall Street Journal.

The uproar surrounding the Panama Papers overshadowed another important development concerning AML compliance. On April 1st, FinCEN requested comments on a proposed rule that would amend the definitions of “broker or dealer in securities” and “broker-dealer” under the regulations implementing the BSA to explicitly include funding portals that are involved in the offering and selling of crowdfunding securities. The proposal notes that Title III of the JOBS Act amends the Securities Act and Securities Exchange Act to include an exemption for crowdfunding portals from the requirement to register with the SEC as a broker. Since BSA requirements for maintaining AML programs extend only to persons who are required to register with the SEC as a broker or dealer, crowdfunding portals would not be subject to current BSA regulations. In its explanation of the proposed amendments, FinCEN maintains that a funding portal’s activities are similar to that of an introducing broker and subject to the same degree of AML risk as registered brokers.  An industry observer cited by Crowdfund Insider raised concerns that the proposed rule, in its attempt to clarify the obligations of funding portals, will lead to greater confusion by blurring the distinction between registered funding portals and registered broker-dealers. Comments on the proposed amendment should be submitted on or before June 3, 2016.

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


Comptroller Discusses Innovation During Retail Banking Conference

On April 7th, Comptroller of the Currency Thomas J. Curry discussed innovation and its impact on retail banking during an appearance at the American Banker Retail Banking Conference. OCC Press Release.


FDIC Rescinds De Novo Time Period Extension and Releases Supplemental Guidance on Business Planning

On April 6th, the Federal Deposit Insurance Corporation (“FDIC”) rescinded Financial Institution Letter 50-2009,Enhanced Supervisory Procedures for Newly Insured FDIC-Supervised Depository Institutions, which extended the de novo period for newly organized, state nonmember institutions from three to seven years for examinations, capital maintenance, and other requirements. It was issued against the backdrop of an elevated number of newly insured institutions that had either failed or had been identified as problem banks during the financial crisis. Since the issuance of the guidance, the FDIC has adopted regulations and guidance that apply to all supervised institutions to strengthen their resiliency and risk-management practices. The FDIC also issued a supplement to its November 2014 guidance related to the Statement of Policy on Applications for Deposit Insurance. The guidance is in a question-and-answer format to aid applicants who are developing proposals for deposit insurance. The supplemental questions and answers focus on the development of business plans. FDIC Press Release.

FDIC Releases Publication Focused on Corporate Governance

On April 5th, the FDIC issued a special edition of Supervisory Insights, “A Community Bank Director's Guide to Corporate Governance: 21st Century Reflections on the FDIC Pocket Guide for Directors,” whichreviews the Pocket Guide and incorporates more recent guidance and technical resources to help board members effectively fulfill their role and duties. FDIC Press Release.

FDIC Issues List of Banks Examined for CRA Compliance

On April 4th, the FDIC issued its list of state nonmember banks recently evaluated for compliance with the Community Reinvestment Act (“CRA”). The list covers evaluation ratings that the FDIC assigned to institutions in January 2016. FDIC Press Release.

Federal Reserve

FRB Proposes Technical Amendments to Rule Requiring GSIBs to Hold Extra Amounts of Risk-Based Capital

On April 7th, the Federal Reserve Board (“FRB”) proposed technical amendments to its rule requiring global systemically important bank holding companies (“GSIBs”) to hold additional amounts of risk-based capital. The proposal would not materially change the underlying rule finalized by the FRB in 2015, which established the criteria for identifying a firm as a GSIB and the methodology that a GSIB must use to determine its risk-based capital surcharge, which corresponds to the systemic risk of that firm. The proposed amendments clarify that GSIBs must continue to calculate their surcharges using year-end data, while their related surcharge data will be reported on a quarterly basis. The proposal also clarifies that these firms are required to compute their surcharge scores using billions of dollars. In addition, the amendments provide additional information on how GSIBs should calculate their short-term wholesale funding scores, which help to determine their surcharges, during the rule’s transition period. Comments will be accepted by May 13, 2016. Federal Reserve Board Press Release.

Treasury Department Developments

Deputy Assistant Secretary Delivers Remarks at the SIFMA Anti-Money Laundering & Financial Crimes Conference.

On April 7th, Deputy Assistant Secretary Jennifer Fowler delivered a speech at the Securities Industry and Financial Markets Association (“SIFMA”) Anti-Money Laundering & Financial Crimes Conference, in which she discussed the Treasury Department’s efforts to combat threats to the integrity of the financial system. Treasury Department Press Release.

Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping.

On April 4th, the Treasury Department and the Interal Revenue Service (“IRS”) issued temporary and proposed regulations to further reduce the benefits of and limit the number of corporate tax inversions, including by addressing earnings stripping. By undertaking an inversion transaction, companies move their tax residence overseas to avoid U.S. taxes without making significant changes in their business operations. After an inversion, many of these companies continue to take advantage of the benefits of being based in the U.S., while shifting a greater tax burden to other businesses and American families. Treasury Department Press ReleaseTreasury Department Fact SheetLew Remarks.

Counselor to the Secretary and Deputy Assistant Secretary for Financial Institutions speaks at FRB of Boston’s Cybersecurity Conference 2016

On April 4th, Anjan Mukherjee, Counselor to the Secretary and Deputy Assistant Secretary for Financial Institutions, gave a speech at the Federal Reserve Bank of Boston’s Cybersecurity Conference 2016 in which he highlighted how areas of financial regulatory reform can inform the development of cybersecurity policy in the financial sector. Treasury Department Press Release.

Securities and Exchange Commission

SEC Announces Equity Market Structure Advisory Committee Meeting

The SEC’s Equity Market Structure Advisory Committee will meet on April 26, 2016, to discuss updates and potential recommendations from its four subcommittees. Written statements should be submitted on or before April 20, 2016. SEC Commission Notice 34-77543.

SEC Seeks Comments on PCAOB’s Proposed Amendments to Inspections of ‘Substantial Role Only’ Firms

The SEC provided notice on April 7th of a proposed rule change filed by the Public Company Accounting Oversight Board (“PCAOB”) that would amend its rules related to inspections. Among other things, the proposal would replace the requirement that the PCAOB inspect firms that play a substantial role in audits but do not issue audit reports every three years with the requirement that it inspect at least five percent of such firms every year. Comments should be submitted within 21 days of publication in the Federal Register. SEC Release No. 34-77558.

Division of Investment Management Exempts Eight More Exchanges from Tick Size Pilot Data Collection Requirements

On April 4th, the SEC’s Division of Investment Management issued exemptions under Rule 608(e) of Regulation NMS to the Chicago Stock Exchange, Inc. (“CHX”), the National Stock Exchange, Inc. (“NSX”), the Nasdaq Stock Market LLC (“Nasdaq”), NASDAQ OMX BX, Inc. (“BX”), NASDAQ OMX PHLX LLC (“PHLX”), the New York Stock Exchange LLC (“NYSE”), NYSE Arca, Inc. (“NYSE Arca”) and NYSE MKT LLC (“NYSE MKT”) from certain data collection requirements established under the Plan to Implement a Tick Size Pilot Program.

Investor Advocate Warns of Potential for Misleading Confirmation Disclosures in MSRB’s Proposed PMP Guidance

On March 31st, SEC Investor Advocate Rick Fleming responded to the Municipal Securities Rulemaking Board’s (“MSRB”) request for comments on its proposed guidance for establishing the prevailing market price (“PMP”) and calculating mark-ups and mark-downs for principal transactions in municipal securities. While he praised the proposal’s attempt to harmonize the MSRB’s guidance with guidance from the FINRA on determining the PMP for other fixed-income securities, Fleming expressed concern regarding the potential for manipulation of the PMP calculation if the guidance is adopted for confirmation disclosure purposes. Investor Advocate Letter.

SEC’s Office of Minority and Women Inclusion Annual Report to Congress

The SEC’s Office of Minority and Women Inclusion published its annual report to Congress on March 31st. The report, as mandated by the Dodd-Frank Act, provides an overview of the SEC’s efforts to enhance diversity in its workforce and promote the use of minority-owned and women-owned businesses in its business activities. The report also addresses the challenges the SEC encountered in hiring qualified minority and women employees, contracting with qualified minority-owned and women-owned businesses, and operating minority and women outreach programs. Office of Minority and Women Inclusion Annual Report.

Commodity Futures Trading Commission

CFTC’s 2016 SmartCheck Week to Emphasize Continual Background Checks of Financial Professionals

On April 7th, the CFTC promoted SmartCheck Week, April 11th through April 17th, during which it encourages consumers to use free online tools to perform an annual check of the background of their financial professionals before investing their money and to do continual checks for the time they are entrusting them with their money.CFTC Press Release.

Market Advisory Risk Committee Is Holding a Public Meeting

On April 5th, the CFTC announced that its Market Risk Advisory Committee (“MRAC”) will hold a public meeting on April 26, 2016 at the CFTC’s Washington, D.C. headquarters. The MRAC will describe and discuss how well the derivatives markets are currently functioning, including the impact and implications of the evolving structure of these markets on the movement of risk across market participants. CFTC Press Release.

CFTC Approves Proposed Guidance Relating to the Appropriate Treatment of Certain Electric Power and Natural Gas Contracts

On April 4th, the CFTC approved proposed guidance relating to the appropriate treatment of certain electric power and natural gas contracts. More specifically, the CFTC has proposed guidance that certain capacity contracts in electric power markets and certain natural gas contracts should not be considered “swaps” under the Commodity Exchange Act (“CEA”) because they are examples of customary commercial arrangements as described in the final rule defining the term “swap.” The public comment period on all aspects of this proposed guidance will close 30 days after publication in the Federal Register. CFTC Press ReleaseMassad Statement.

CFTC Announces Whistleblower Award of Over $10 Million

On April 4th, the CFTC announced an award of more than $10 million to a whistleblower who provided key original information that led to a successful CFTC enforcement action. The award is the largest made by the CFTC’s Whistleblower Program to date and the third award to a whistleblower who provided valuable information about violations of the CEA. CFTC Press Release.

Federal Rules Effective Dates

Click here to view table.

Exchanges and Self-Regulatory Organizations

Chicago Board Options Exchange

SEC Approves CBOE Rule Amendments Relating to LLMs and DPMs

On April 7th, the SEC approved the Chicago Board Options Exchange, Incorporated’s (“CBOE”) proposal to amend its rules relating to Lead Market-Makers (“LLMs”), Designated Primary Market-Makers (“DPMs”) and Supplemental Market-Makers (SMMs”) to modify the descriptions of certain obligations of LLMs and DPMs, delete outdated references to SMMs, and make other clarifying changes. SEC Release No. 34-77553.

CBOE Proposes Amendments to Clarify Treatment of AIM Auction Orders

On April 4th, the SEC requested comments on a proposed rule change filed by the CBOE that would clarify how orders submitted for electronic crossing into the Automated Improvement Mechanism (“AIM”) auction are treated if an auction cannot occur, describe the CBOE’s AIM Retained Order functionality in the rules, and make other minor edits and technical corrections to the rules relating to the treatment of complex AIM orders marked as AIM Retained Orders. Comments should be submitted on or before April 29, 2016. SEC Release No. 34-77511.

Financial Industry Regulatory Authority

SEC Approves FINRA Rule Governing Outside Accounts

On April 7th, the SEC announced that it has approved FINRA’s proposal to adopt a new rule in the Consolidated FINRA Rulebook that would require associated persons to obtain their employer firms’ permission before opening or establishing accounts in which securities transactions can be effected and in which they have a beneficial interest at an outside broker-dealer or any other financial institution. SEC Release No. 34-77550.

FINRA Proposal to Identify Non-FINRA Member Broker-Dealers on OATS Reports Gains SEC Approval

On April 5th, the SEC approved FINRA’s proposal to amend its rules to require FINRA members to include the identity of broker-dealers who are not FINRA members on their Order Audit Trail System (“OATS”) reports when the member receives an order from such a broker-dealer. SEC Release No. 34-77523.

FINRA Expands Application of OBS to Non-Carrying/Non-Clearing Firms with Significant Off-Balance Sheet Obligations

FINRA announced on April 5th that the SEC approved its proposal to amend the instructions to the Derivatives and Other Off-Balance Sheet Items Schedule (“OBS”) to expand the application of the OBS. Under the amended instructions, all FINRA member firms that self-clear their proprietary transactions, clear transactions for others, or carry customer accounts and all other FINRA member firms that have a minimum dollar net capital requirement equal to or greater than $100,000 and at least $10 million in reportable items must file the OBS. Firms that fall under the expanded application of the OBS must file their initial OBS disclosing off-balance sheet information as of June 30, 2016, on or before August 2, 2016. FINRA Regulatory Notice 16-11.

FINRA, MSRB Offer Guidance on Alternative Financing Transactions Involving Direct Purchases and Bank Loans

FINRA and the MSRB published guidance on April 5th to remind firms of their obligations in connection with direct purchases and the use of bank loans in the municipal securities market. The regulators noted that firms may not be conducting adequate due diligence to determine whether the financing instruments are municipal securities, what the nature of their role is in the transaction, and whether FINRA and MSRB rules, as well as federal securities laws, apply to the transactions. FINRA Regulatory Notice 16-10.

International Securities Exchange

ISE Mercury Proposal Would Designate Certain PMMs to Participate in Regulation SCI Testing

On April 7th, the SEC requested comments on a proposed rule change filed by ISE Mercury, LLC (“ISE Mercury”) that would amend its rules to limit mandatory participation in scheduled functional and performance testing under Regulation SCI to certain Primary Market Makers (“PMMs”), which would include PMMs that contribute a meaningful percentage of ISE Mercury’s overall volume as measured on a quarterly or monthly basis. The proposal would also establish the criteria and factors the exchange would use in determining which PMMs would be subject to functional and performance testing, such as the daily volume traded on the exchange or accounting for a certain percentage of market share on the exchange or within a specific product. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of April 11, 2016.SEC Release No. 34-77556.

International Swaps and Derivatives Association

ISDA Announces Revisions to SIMM Licensing Program

On April 5th, the International Swaps and Derivatives Association (“ISDA”) announced that is has revised the licensing program for its Standard Initial Margin Model (“SIMM”), which is its proprietary, patent-pending margin model for non-cleared derivatives. The revised licensing program will permit any market participant to license the ISDA SIMM to calculate initial margin for its own or its clients’ non-cleared derivatives transactions and will allow third-party vendors to license the ISDA SIMM for proprietary services or products. An annual licensing fee will apply to all users of the ISDA SIMM. ISDA Press Release.

Municipal Securities Rulemaking Board

MSRB Proposes Amendments to Minimum Denomination Rule

On April 7th, the MSRB published proposed amendments to its minimum denomination rule, which prohibits brokers, dealers, and municipal securities dealers from trading certain securities that may be inappropriate for a retail customer with customers below a stated minimum denomination. The proposed amendments would clarify exceptions to the rule by adding two additional trading scenarios that would be excluded from the rule’s prohibition on sales to customers below the minimum denomination to preserve liquidity for investors. Comments should be submitted on or before May 25, 2016. MSRB Press Release.


NYSE Exchanges Propose Changes to Opening Process for Trading in an Options Series.

On April 6th, the SEC requested comments on NYSE Arca’s and NYSE MKT’s separately filed proposals to amend their respective rules to modify the process for opening trading in an options series. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of April 11, 2016.

SEC Seeks Comments on NYSE Exchanges’ Proposed Revisions to EOC Order Entry Requirements

On April 5th, the SEC provided notice of NYSE Arca’s and NYSE MKT’s separately filed proposals to amend their respective rules to modify the requirements for entering an order into the Electronic Order Capture System (“EOC”) by eliminating the pre-trade EOC requirement that Options Trading Permit (“OTP”) Holders or OTP Firms give up the name of the Clearing Member responsible for clearing each trade before representing a trade in an open outcry. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of April 11, 2016.

Industry News

U.S. Supreme Court to Hear Appeal of Securities Fraud Conviction.

DealBook reported on the U.S. Supreme Court’s upcoming decision on the appeal of the Salman v. United Statessecurities fraud conviction. On April 7th, DealBook wrote that in its next term, which begins in October 2016, the Court will consider what evidence the government must introduce in order to prove that a benefit passed between a source of confidential information and the recipient who trades on it, called the “tippee.” Until the Court issues its decision, the Justice Department and the SEC must apply the law in its current form, which includes a conflict over what is needed to prove that a tippee violated the law. DealBook.

SEC to Review ‘Panama Papers’

On April 7th, Reuters reported that Kara Novaco Brockmeyer, chief of the SEC’s Foreign Corrupt Practices Act (“FCPA”) unit, said at an industry conference that the SEC will be reviewing the leaked “Panama Papers,” which exposed holders of thousands of hidden bank accounts, for possible violations of anti-bribery law. Reuters.

U.S. Senate Panel Delays SEC Nominations

On April 7th, Bloomberg reported that the Senate Banking Committee has delayed action on SEC nominees Hester Peirce and Lisa Fairfax due to concerns that the nominees would not push for new disclosure requirements on corporations’ political spending. Because of this delay, the SEC continues to lack a complete roster of commissioners. Bloomberg.

New Retirement Advice Rule Is Weakened

On April 6th, Reuters reported that, in response to pressure from the financial services industry, a new U.S. rule intended to protect retirement savers from profit-hungry brokers is considerably weaker than an initial proposal. The rule sets a fiduciary standard for financial brokers who sell retirement products, requiring them to put their clients’ best interests ahead of their bottom line. Unlike the initial proposal, the Labor Department’s final rule does not restrict brokers from pushing proprietary products, splitting revenue with creators of funds that they promote, or recommending risky, high-fee investments in alternative assets and certain annuities. Brokers have also been granted more time to implement the changes, which they argued were costly and difficult. The rule will now take full effect on January 1, 2018, compared with an eight-month compliance deadline in the initial proposal. Reuters. See also The Wall Street JournalLew Statement.

Group of Hedge Funds Sues to Freeze Assets of Puerto Rico’s Bank

On April 4th, The New York Times reported that a group of hedge funds has asked the U.S. District Court in San Juan to freeze the assets of Puerto Rico’s Government Development Bank, contending that it was insolvent and appeared to be spending the cash it had left to prop up other parts of the island’s troubled government. The hedge funds alleged that the bank failed to provide financial information to which creditors were entitled under federal law, and asked the court to bar further cash transfers by the bank, other than those essential to the safety and well-being of the island’s residents. The New York Times.