Insights from Winston & Strawn

On August 5, 2016, the Commodity Futures Trading Commission (the “CFTC”) proposed amending certain CFTC regulations relating to the requirement that a commodity pool operator (“CPO”) distribute an audited annual report for each commodity pool that it operates.

Section 4 of the CFTC regulations requires each CPO registered or required to be registered to, among other things, distribute to each participant an audited annual report for the pool within 90 calendar days after the end of the pool’s fiscal year.  While the CFTC has periodically provided on a case-by-case basis relief from certain of the annual reporting requirements, the proposed amendment would codify certain of these exemptions.

The proposed amendment would modify Regulation 4.22(g)(2) to exempt from the audit requirement a pool that meets the following criteria: (1) the time period from the formation of the pool to the end of the pool’s first fiscal year must be three months or less; (2) there must be no more than 15 participants in the pool during such time period; and (3) the total gross capital contributions received by the CPO during such period for units of participation in the pool must not exceed $1,500,000 (excluding the CPO, its commodity trading advisor, their respective principals, and each of their respective spouses, relatives, or any entity wholly owned by any of the participants).

To claim relief under the proposed exemption, a CPO would be required to (1) obtain from each person who has been a pool participant during the initial fiscal year a written waiver of such person’s right to receive an audited annual report for that initial fiscal year; (2) on or before the date that the first annual report is due, file a notice of claim with National Futures Association (“NFA”), along with a certification that the CPO had received a waiver from each of the pool’s participants; and (3) include on the cover of each annual report for which relief had been claimed a prescribed statement that provides information on whether the annual report was unaudited or audited and the period of time that the annual report covered.  Finally, the next annual report distributed by the CPO must be audited and must also cover the period from the formation of the pool through the end of the pool’s first full fiscal year.

In addition to the audit exemption described above, the proposed amendment would allow the use of generally accepted accounting principles, standards, or practices followed in the U.K., Ireland, Luxembourg, or Canada upon filing a signed notice with the NFA representing that: (1) the pool is organized under the laws of a foreign jurisdiction; (2) the Annual Report will include a schedule of investments, (3) the use of the applicable principles, standards, or practices to prepare the Annual Report is not inconsistent with representations set forth in the pool’s disclosures to participants; (4) any special allocations of ownership equity will be reported in accordance with applicable CFTC regulations; and (5) in the event that the applicable principles, standards, or practices require consolidated financial statements for the pool, all applicable disclosures required by U.S. GAAP will be provided.

Winston & Strawn will continue to monitor the progress of this proposal as it winds its way through the comment process.  Comments to the proposed amendment must be received on or before September 6, 2016.

Feature: Review of Recent Compliance Program and Executive Compensation Surveys

Below is a recap of a compliance program survey and an analysis of executive pay compensation as recently summarized by the Wall Street Journal:

Survey on Primary Objective for Compliance Programs

According to “2016 Compliance and Ethics Program Objectives Survey,” a survey conducted by the Society of Corporate Compliance and Ethics to determine the primary objective for compliance programs, 49.5% of compliance and ethics professionals said that promoting an ethical culture is the primary objective of an ethics and compliance program, while 35.4% said that preventing and detecting misconduct was the second most important objective. Other objectives, including meeting a regulatory requirement, protecting corporate reputation, and protecting directors and officers were cited far less often. The report found surprising the number of compliance and ethics professionals who see the primary objective of a compliance program to be promoting an ethical culture, as many have claimed that the rise of compliance programs has somehow shoved ethics to the side.

The survey showed that compliance professionals do not look at compliance programs in the same way that management looks at the same compliance programs. When asked what they thought management saw as the top objectives of a compliance program, 42.6% thought that management saw meeting regulatory requirements as the primary objective, while 29% said that preventing and detecting misconduct was the primary objective and 13.3% said that promoting an ethical culture was the primary objective, followed by protecting corporate reputation, protecting directors and officers, and reducing criminal penalties. The report concluded that the survey findings show “that management may not be fully bought into the value of compliance program for protecting the business and serving as an extension of the company’s commitment to its values … This attitude likely furthers a belief in workers that compliance is a chore designed to meet the expectations of outsiders and does not reflect an internal commitment by the business.”

Compliance professionals also feel that board members look at compliance programs in a very different way. When asked what they thought the board saw as the primary objective of the ethics and compliance program, 27.9% responded “to prevent and detect misconduct.” 24.2% of those surveyed thought that the board saw the primary objective to be meeting a regulatory requirement, followed by protecting corporate reputation, promoting an ethical culture, protecting directors and officers, and reducing criminal penalties.

The report found it disturbing that compliance and ethics professionals see themselves, their managers and boards having different primary goals for their compliance program, but suggested that conflict between management and the board would be lessened if they could somehow ensure consistency in expectations for their compliance programs.

Analysis of Executive Compensation

Global advisory, broking and solutions company Willis Towers Watson concluded in “Executive Compensation Bulletin” (its annual analysis of director compensation at Fortune 500 companies) that the total direct compensation for directors at the largest U.S. companies increased by 3% in 2015, to $263,500, an increase from nearly $255,000 in 2014, thanks to increases in cash and stock compensation. See here for an analysis of how workers feel about how much their company’s CEO earns.

The study also determined that the annual cash retainer for board service reached $100,000 for the first time as companies continue to push toward a fixed approach to director pay.Robert Mustich, leader of Willis Towers Watson’s Executive Compensation Consulting practice in the eastern U.S., noted that “[c]ompanies continue to adjust their director pay programs with an eye toward rewarding directors for their overall contributions rather than for how many meetings they attend … [t]he fact that a third of the companies we analyzed changed one or more core elements of their pay program in the past year reflects an ongoing trend toward companies reviewing and adjusting their director pay packages on a regular basis to remain competitive.” Other survey findings include the fact that companies continue to embrace stock ownership guidelines and retention requirements for directors; and companies are imposing caps on directors’ potential stock grants in response to recent court decisions.

See here for a summary of an April 21st proposal by the National Credit Union Administration (“NCUA”) on incentive-based compensation for all financial institutions. The proposed rule would require affected institutions to annually create and retain records documenting the structure of incentive-based compensation arrangements for seven years. The NCUA proposed rule would also require board members to provide direct oversight of compensation, including approval of all senior executive compensation plans and any material adjustments. Following up on the NCUA’s proposal, five other federal financial regulators (the FDIC, OCC, Federal Reserve, Federal Housing Finance Agency and the SEC) on May 16th issued an interagency proposed rule to prohibit incentive-based compensation arrangements that encourage inappropriate risks at large financial institutions. The comment period on this proposal closed on July 22nd. See here for a sampling of industry comments.

Banking Agency Developments


OCC Names Peggy Sherry Deputy Chief Financial Officer

On August 3rd, the Office of the Comptroller of the Currency (“OCC”) announced that it has selected Peggy Sherry to be its Deputy Chief Financial Officer. In this role, Ms. Sherry will oversee the agency’s planning and execution of our annual operating budget. In addition to her financial duties, Ms. Sherry will be responsible for the oversight of the agency’s financial systems, internal and financial controls program, travel policy and operations, and agency records management functions as well as the OCC’s Office of Management’s compliance and strategic planning functions. She assumes these duties in September, succeeding Gary Crane, who is retiring.

Regulated Institutions to Submit Self-Assessments of Diversity Policies and Practices

On August 2nd, the OCC, the Board of Governors of the Federal Reserve System and the FDIC have provided information on how the financial institutions they regulate may begin to submit self-assessments of their diversity policies and practices as of year-end 2015, and issued Frequently Asked Questions about the process.

Agencies Finalize Rule Exempting Certain Commercial and Financial End Users from Initial and Variation Margin Requirements

On August 1st, five federal agencies announced a final rule exempting certain commercial and financial end users from margin requirements for certain swaps not cleared through a clearinghouse. In a separate rulemaking published in 2015, the Federal Reserve Board, the OCC, the FDIC, the Federal Housing Finance Agency, and the Farm Credit Administration established initial and variation margin requirements for non-cleared swaps, as required by Dodd-Frank. The final rule, among other things, exempts from the agencies’ margin requirements the non-cleared swaps of commercial end users, small banks, savings associations, Farm Credit System institutions, and credit unions with $10 billion or less in total assets.

OCC to Host Credit and Compliance Risks Workshops in Minnesota

On August 1st, the OCC announced that it will host two workshops in Duluth, Minnesota, at the Holiday Inn Hotel & Suites, September 13-14, for directors of national community banks and federal savings associations supervised by the OCC. The Credit Risk workshop on September 13th will focus on credit risk within the loan portfolio, such as identifying trends and recognizing problems. The workshop will also cover the roles of the board and management, how to stay informed of changes in credit risk, and how to effect change. The Compliance Risk workshop on September 14th will combine lectures, discussion, and exercises on the critical elements of an effective compliance risk management program. The workshop will also focus on major compliance risks and critical regulations. Topics of discussion include the Bank Secrecy Act, Community Reinvestment Act, and the Truth-in-Lending and the Real Estate Settlement Procedures Act of 1974 Integrated Disclosures Rule (“TRID”).


FDIC Extends Comment Period on Third-Party Lending Guidance

On August 4th, the Federal Deposit Insurance Corporation (“FDIC”) announced that it is extending the comment period for proposed guidance on third-party lending. Comments on the proposed guidance, which was published on July 29th, now must be received on or before October 27th.

Agencies Extend Deadline for 38 Resolution Plan Submissions

On August 2nd, the Federal Reserve Board and the FDIC announced that 38 firms will be required to submit their next resolution plans by December 31, 2017. The firms were previously required to submit their next plans by December 31, 2016. These firms include 36 domestic bank holding companies and foreign banking organizations, as well as two nonbank financial companies designated by the Financial Stability Oversight Council (“FSOC”). The agencies expect to provide feedback and guidance based on the firms' December 2015 plans for use in their December 2017 submissions.


FFIEC Invites Comment on Streamlined “Call Report” for Small Institutions

On August 5th, the federal banking agencies, as members of the Federal Financial Institutions Examination Council (“FFIEC”), requested public comment on a proposal for a new and streamlined “Call Report” for small financial institutions. The changes are intended to ease reporting requirements and reduce reporting burden for small financial institutions. The agencies also requested comments on certain proposed revisions to the two existing versions of the Call Report, which would remain applicable to institutions not qualifying for the streamlined Call Report. The requested comments on the proposed changes should be submitted no later than 60 days after the date of their publication in the Federal Register.

Securities and Exchange Commission

Joint Agency Statement on the Review of the U.S. Treasury Market

The Securities and Exchange Commission (“SEC”), along with the Treasury Department, the Federal Reserve Board, the Commodity Futures Trading Commission (“CFTC”), and the Federal Reserve Bank of New York issued a joint statement on August 2nd regarding the progress the agencies have made in their review of the U.S. Treasury Market since the release of their Joint Staff Report last year. In the joint statement, the agencies noted the steps they have taken to promote understanding, transparency, risk management, and inter-agency coordination with respect to the U.S. Treasury market, highlighting a memorandum of understanding that will permit the agencies to share information with each other on U.S. Treasury cash and related derivative markets. The agencies indicated that they will take additional measures to address the Joint Staff Report’s recommendations, including hosting a second conference on October 24, 2016, to discuss the evolution of the U.S. Treasury market and related policy initiatives. SEC Press Release.

Equity Market Structure Advisory Committee Meeting

The SEC’s Equity Market Structure Advisory Committee met on August 2nd to discuss recommendations from its Market Quality subcommittee on the National Market System (“NMS”) Plan to Address Extraordinary Volatility, market-wide circuit breakers, and the market opening. The Committee also discussed recommendations from its Customer Issues subcommittee on an investor sentiment benchmark and changes to SEC Rules 605 and 606. In her opening remarks, SEC Chair Mary Jo White noted that the SEC will likely consider the Committee’s recommendation regarding an access fee pilot later this year and that SEC staff is currently evaluating the Committee’s trading venues recommendations. SEC Commissioner Michael S. Piwowar praised the Customer Issues subcommittee’s recommendation on an investor sentiment benchmark, noting that it had the potential to “facilitate investors making informed choices about investment venues, strategies, and products.”

Piwowar Advocates for Market-Based Prudential Regulation of Banks

On August 1st, the SEC published SEC Commissioner Michael S. Piwowar’s remarks to the Quadrilateral Meeting of the FMLC/FMLG/FLB/EFMLG in London. Piwowar registered his opposition to the prudential regulation of capital markets advocated by banking regulators and suggested instead that banks should be subject to “the disclosure-oriented focus of market-based regulation.” Piwowar identified five areas that would benefit from improved disclosures by banks, including bank investment portfolios; bank loan portfolios; the impact from the comprehensive capital analysis and review process; resolution plans; and material regulatory costs.

SEC Extends Date to Take Action on Consolidated Audit Trail Plan

The SEC announced on July 29th that it will take additional time to consider comments on a joint proposal by several self-regulatory organizations (“SROs”) for an NMS plan governing the Consolidated Audit Trail. In its notice, the SEC designated November 10, 2016, as the date by which it will take action on the proposed plan.SEC Release 34-78441.

Commodity Futures Trading Commission

Proposed Rules

CFTC Proposes to Amend Regulations Applicable to Commodity Pool Operator Annual Report

On August 5th, the CFTC proposed to amend certain of its regulations applicable to the Annual Report that each person registered or required to be registered as a commodity pool operator (“CPO”) must distribute for each commodity pool that it operates. The proposal specifically addresses the use of additional alternative generally accepted accounting principles, standards or practices, and the Annual Report audit requirement where the first fiscal year of a pool consists of a period of three months or less from the date of formation of the pool. Comments must be received on or before September 6, 2016.

CFTC Proposes to Amend Exemption from Registration for Certain Foreign Persons

On August 5th, the CFTC proposed to amend the condition under which persons located outside the U.S. who are acting in the capacity of a futures commission merchant, an introducing broker, a commodity trading advisor, or a CPO in connection with commodity interest transactions exclusively on behalf of those located outside the U.S., or on behalf of certain international financial institutions, would qualify for an exemption from registration with the CFTC. Comments must be received on or before September 6, 2016.

Other Developments

CFTC Announces Two Related Cross-Border Actions

On August 4th, the CFTC announced two separate actions on how the rules related to the Dodd-Frank Act apply to cross-border transactions. In the first action, the CFTC issued a Final Response to District Court Remand Order in Securities Industry and Financial Markets Association, et al. v. United States Commodity Futures Trading Commission, where the CFTC prevailed in most respects on a challenge by industry groups to its authority to regulate cross-border swaps transactions. See here for Commissioner J. Christopher Giancarlo’s response to the Order. Also, the CFTC’s Divisions of Swap Dealer and Intermediary Oversight, Clearing and Risk, and Market Oversight issued a time-limited no-action letter extending relief, which was originally provided in November 2013 and subsequently extended, to swap dealers registered with the CFTC that are established under the laws of jurisdictions other than the U.S. from certain transaction-level requirements under the Commodity Exchange Act. See here for Chairman Timothy Massad’s statement on the CFTC’s actions related to the overseas application of its swaps rules.

Federal Rules Effective Dates

Click here to view table.

Exchanges and Self-Regulatory Organizations

Financial Industry Regulatory Authority

FINRA Initiates Examination of Business Development Companies

The Financial Industry Regulatory Authority (“FINRA”) published a targeted exam letter on August 4th that requests information from firms about non-traded Business Development Companies (“BDCs”), including a list of the BDCs offered by the firm, a list of broker-dealers that have selling agreements with the BDCs, and a copy of the firm’s due diligence procedures related to BDCs. In comments published by Investment News, FINRA spokeswoman Michelle Ong explained that the purpose of the exam is to assess how firms market and sell BDCs, which can be risky investments, to retail investors. FINRA Targeted Exam Letter.

FINRA Prepares Firms for Changes to the Operation of the LULD Plan Following Trading Pauses

FINRA published a Regulatory Notice on July 29th that describes amendments to FINRA rules approved by the SEC to clarify the operation of the Regulation NMS Plan to Address Extraordinary Volatility (“LULD Plan”) following a trading pause or regulatory halt in a security subject to the LULD Plan. Under the amended rules, which will become effective on August 22, 2016, a firm may resume trading in these securities on the condition that trading has started on the primary listing exchange and the firm either has received the price bands from the processor or the firm has calculated an upper price band and lower price band consistent with the LULD Plan’s methodology. FINRA Regulatory Notice 16-26.


ICC Proposes Changes to ICC Risk Management Framework

On July 29th, the SEC requested comments on a proposed rule change filed by ICE Clear Credit LLC (“ICC”) that would, among other things, revise the ICC Risk Management Framework to include risk model enhancements related to the single name credit default swap liquidity charge methodology. Comments should be submitted on or before August 25, 2016. SEC Release No. 34-78448.

International Swaps and Derivatives Association

ISDA Announces Launch of ISDA Amend 2.0

On August 4th, the International Swaps and Derivatives Association (“ISDA”) announced that it, along with IHS Markit, launched ISDA Amend 2.0, an upgraded version of its online service that permits users to amend multiple ISDA Master Agreements and share regulatory representations. The new functionality included in ISDA Amend 2.0 will allow market participants to implement new margining requirements for non-cleared derivatives and notify counterparties of their elections under the ISDA Resolution Stay Jurisdictional Modular Protocol. ISDA Press Release.

ISDA Updates Compliance Calendar for OTC Derivatives

On August 1st, ISDA published an updated version of its OTC Derivatives Compliance Calendar. OTC Derivatives Compliance Calendar.

Municipal Securities Rulemaking Board

MSRB Announces Officers and New Members of Its Board of Directors for Fiscal Year 2017

On August 2nd, the Municipal Securities Rulemaking Board (“MSRB”) announced the new officers and members of its Board of Directors for the 2017 fiscal year. The new officers and board members will begin their terms on October 1, 2016. MSRB Press Release.

MSRB Board of Directors Quarterly Meeting

On August 1st, the MSRB issued an update on the actions taken by its Board of Directors at its quarterly meeting, which took place on July 27-28 2016. The Board voted to propose amendments to MSRB rules related to customer and client complaints, mark-up disclosure by municipal securities dealers, and the definition of an underwriter. The Board also agreed to file two rule interpretations related to municipal advisors who provide advisory services to sponsors of Achieving a Better Life Experience (“ABLE”) programs and declined to pursue rulemaking on bank loan disclosures. MSRB Press Release.


Nasdaq Proposes New Market Data Service

On August 2nd, the SEC requested comments on The NASDAQ Stock Market LLC’s (“Nasdaq”) proposal to adopt a new rule governing Nasdaq Trading Insights, an optional market data service that would include additional market data components to assist market participants in identifying opportunities to access liquidity and to receive better execution rates. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of August 8, 2016. SEC Release No. 34-78462.


SEC Takes More Time to Consider NYSE’s Proposed Changes to Trading Floor Definition

On July 29th, the SEC designated September 15, 2016, as the date by which it will approve, disapprove, or institute disapproval proceedings regarding the New York Stock Exchange LLC’s (“NYSE”) proposal to amend its rules to exclude an area within fully enclosed telephone booths located in 18 Broad Street from the definition of “trading floor.” SEC Release No. 34-78442.

Industry News

Study Finds That Hedge Fund Activism Benefits Targeted Companies

On August 5th, CFO reported on a study’s findings that hedge fund activism, which is commonly seen as a short-term money grab, generally results in superior stock performance and strengthened company essentials over a long term. The new research, which is to be presented at the annual meeting of the American Accounting Association in New York City from August 5-10, determined that “[a]ctivists are not just good pickers of underpriced stocks; their interventions improve companies’ long-term financial health.”

Exchanges Amplify Rules to Crack Down on Spoofing

On August 3rd, Bloomberg reported that exchanges are cracking down on brokers that enable foreign day traders who break rules and dodge regulators. Chris Concannon, the CEO of Bats Global Markets Inc., is leading the charge on these brokers, whose clients engage in illegal practices such as spoofing, by barring them within weeks rather than in the months or years that it used to take. Bats has also introduced a community watch-style program to encourage more brokers to basically snitch on their peers when they suspect market manipulation. Nasdaq adopted a similar rule that allows it to quickly block brokers with dishonest customers, NYSE Group reminded its customers of what constitutes manipulation, and FINRA plans to modify its rulebook to step up enforcement against such corruption.

Regulators Are Asking Banks for More Details on Their Trading Businesses

On August 2nd, the Wall Street Journal reported that regulators are asking big banks to give investors more detailed disclosures about their trading businesses. While trading revenues are now lumped together, which makes it difficult for investors to see what is driving a particular firm’s results, the SEC could in the future ask the banks to break out revenue from individual products like bonds, stocks and commodities.