Insights from Winston & Strawn

SEC’s Division of Investment Management Encourages Funds to Make Risk Disclosures Responsive to Current Market Conditions

The Securities and Exchange Commission’s (“SEC”) Division of Investment Management recently cautioned mutual funds, exchange traded funds and other registered investment companies to keep their risk disclosures updated regularly.  In a new guidance issued on March 9th, the Division highlighted the importance of disclosing risks related to changing market conditions in assisting investors in evaluating investment risks.  

The Division suggested funds actively monitor market conditions and their impact on fund risks, assess whether material fund risks have been adequately communicated to investors in current disclosure materials and communicate any such material risks to investors that are not adequately communicated in current disclosures.  The key concern is that changing market conditions could cause what was an appropriate disclosure to become inaccurate or incomplete over time.  

For example, in light of the current historically low interest rates, certain fixed income funds have recently been making disclosures regarding interest rate risk and its secondary effects of liquidity risk and duration risk.  Similarly, the developing Puerto Rican debt crisis has triggered updated disclosure by Puerto Rican debt funds and certain tax-exempt funds with significant exposure to Puerto Rican debt.  We assume most funds are already monitoring such market developments for their own business purposes.  These examples merely illustrate the promptness and thoroughness with which the Division expects funds to disclose new material risks, whether by a prospectus, shareholder report or less formal methods, like website disclosures and letters to shareholders.  IM Guidance Update 2016-02.

Feature: Fed Proposal Seeks to Limit Banks’ Credit Exposures to Counterparties

In an effort to fulfill its mandate under the Dodd-Frank Wall Street Reform and Consumer Protection Act and implement measures to ward off another financial crisis, the Federal Reserve Board (the “Fed”) proposed a new rule on March 4th that would place limits on the amount of credit exposures large banking organizations may have to another bank or company. The highly anticipated proposal has been under development since 2011, when the banking industry objected to an earlier version it argued was too stringent and “vastly overestimated [its] exposures,” according to a report in the Wall Street Journal.  

Under the Fed’s latest proposal, single-party credit limits would apply to all bank holding companies with $50 billion or more in total consolidated assets; the limits would become more stringent in relation to the size of the bank, with the largest, global systemically important banks (“G-SIBs”) subject to the strictest requirements:

  • Banks meeting the $50 billion threshold would be required to restrict their credit exposure to a single counterparty to no more than 25 percent of their total regulatory capital;
  • bank holding companies with $250 billion or more in total consolidated assets, or $10 billion or more in on-balance-sheet foreign exposure, would be required to restrict their credit exposure to another counterparty to no more than 25 percent of their tier 1 capital; and
  • G-SIBs would need to restrict their credit exposure to another systemically important financial firm to no more than 15 percent of their tier 1 capital, and up to 25 percent of their tier 1 capital to another counterparty.

Comments on the proposed rule should be submitted on or before June 3, 2016. Federal Reserve Press Release.

In an opening statement, Fed Chair Janet L. Yellen called the rule an “important step to enhance the resiliency and stability of our financial system” and emphasized that the credit limit “sets a bright line on total credit exposures” between banks.  Daniel K. Tarullo (Governor, Federal Reserve Board) noted that although measures already taken by regulators “have reduced interconnections among the largest financial firms by roughly half from pre-crisis days,” the proposed credit limit is a necessary safeguard to ensure that banks do not “return to prior practices.”  

While G-SIBs face heightened restrictions under the proposal, the Fed responded to industry concerns by abandoning an earlier version of the rule that would have set the credit limit for G-SIBs at no more than 10 percent of their capital. According to a report in Bloomberg, the revised proposal responded to other industry concerns as well, such as excluding exposures to “certain clearinghouses and high-quality sovereign debt.” Banking industry consultants applauded the proposal for aligning with international standards rather than “gold-plating” the rule by insisting on more rigorous requirements. Other changes, however, have made the proposal stricter than the original version floated by the Fed. A New York Times article emphasized the importance of the proposed rule’s use of tier 1 capital to measure the credit limit for larger institutions, as it excludes less stable forms of capital resulting in a smaller measure of capital.  

Critics expressed concern regarding the proposal’s approach to measuring derivatives trades, which eliminated the earlier version’s use of the Current Exposure Method (“CEM”) due to industry concerns that the use of CEM might result in the overstatement of a derivatives counterparty’s credit risk. In the New York Times article, Marcus Stanley, policy director for Americans for Financial Reforms, questioned whether the Fed’s approach to derivatives under the rule will adequately account for risks from derivatives exposures, noting that market stress can exacerbate derivatives exposures and their risks.  

While the Fed’s proposed rule takes steps to ensure that banks protect themselves from risks posed by counterparties, a working paper published by the Treasury Department’s Office of Financial Research on March 8th suggests that regulators’ methods for assessing these risks may also need adjusting. The working paper examined data from the credit default swaps market to assess the impact that the default of large counterparties may have on banks. The authors used the Fed’s stress test, the Comprehensive Capital Analysis and Review (“CCAR”), which requires banks to consider the default of the counterparty that owes the bank the most money on credit default swaps during a stress event, to conduct their analysis. Although the Fed’s stress test emphasizes a bank’s direct exposure to its largest counterparty, the authors found that banks’ indirect exposures to the small number of counterparties concentrated in the credit default market under stress could be as much as nine times larger than their direct exposures. The Financial Times quoted Mark Paddrik, one of the study’s authors, who emphasized that stress tests need to consider the entire market, rather than focus on individual institutions, to adequately assess the systemic risks of counterparty relationships.

Banking Agency Developments


OCC to Host Minority Depository Institutions Advisory Committee Meeting

On March 10th, the Office of the Comptroller of the Currency (“OCC”) announced that it will host a public meeting of the Minority Depository Institutions Advisory Committee (“MDIAC”) on Tuesday, April 5, 2016, beginning at 8:00 a.m. EST at its office at 400 7th Street SW, Washington, D.C. The MDIAC advises the OCC on steps the OCC may take to ensure the continued health and viability of minority depository institutions and other issues of concern to these institutions. The OCC must receive written statements no later than Tuesday, March 29, 2016.OCC Press Release.

Comptroller Discusses Global Financial Regulation, Cybersecurity, and Money Laundering Risks

On March 7th, the OCC’s Thomas J. Curry discussed global financial regulation during his remarks at the Institute of International Bankers’ Annual Conference. Comptroller Curry highlighted the importance of international cooperation as well as efforts in the U.S. to improve cybersecurity and fight against money laundering. Comptroller Curry also reiterated the OCC’s expectations and role in banks’ process of reevaluating risk. OCC Press Release.


FDIC Publishes a Bank Customer‘s Guide to Cybersecurity

On March 8th, the Federal Deposit Insurance Corporation (“FDIC”) announced that it has produced a special edition of the agency‘s quarterly FDIC Consumer News (Winter 2016) entitled “A Bank Customer’s Guide to Cybersecurity.” FDIC Press Release.

FDIC Highlights New Resources for Bank Customers on Precautions When Using Computers and the Internet

On March 8th, the FDIC announced that it released two new cybersecurity brochures to educate bank customers about appropriate steps they can take to help avoid fraud and other cyber threats when banking online or on their mobile devices. FDIC Press Release.


FFIEC Appoints Tennessee Commissioner to its State Liaison Committee

On March 9th, the Federal Financial Institutions Examination Council (“FFIEC”) announced the appointment of Tennessee Commissioner Greg Gonzales to its State Liaison Committee (“SLC”). Gonzales’s SLC nomination was confirmed by the Conference of State Bank Supervisors on Feb. 26, 2016, to complete a partial term vacancy created by the resignation of Lauren Kingry. Gonzales’s term will continue through March 31, 2017.FFIEC Press Release.

Securities and Exchange Commission

Exemptive Orders and No-Action Relief

Division of Corporation Finance Grants Exemption from Tender Offer Rules to Harmonize U.S. and Finnish Laws

The SEC’s Division of Corporation and Finance issued a no-action letter on March 8th in which it granted Acorda Therapeutics, Inc.’s request for exemptions from provisions of Securities Exchange Act Rules 14e-1 and 14d-11 in its tender offer for Finnish company Biotie Therapies Oy. Acorda Therapeutics requested the relief to address conflicts between U.S. securities laws and Finnish law and market practice. Under the exemption, the Division will not recommend enforcement action if “the Bidder pays for Securities tendered during the Initial Offer Period . . . within six Finnish banking days after expiration of the Initial Offer and up to nine Finnish banking days in the case of payment for Applicable Other Equity Instruments in certificated form made to bank accounts in financial institutions outside Finland.” SEC No-Action Letter.

Division of Trading and Markets Grants BATS’s Request for Exemption from Tick Pilot Quoting and Trading Requirements

On March 3rd, the SEC’s Division of Trading and Markets published a letter granting BATS Exchange, Inc.’s (“BATS) request for a limited exemption from certain quoting and trading requirements under the Plan to Implement a Tick Size Pilot Program under Regulation NMS. SEC Exemptive Order.

Other Developments

Staff Announcements

Anthony S. Kelly will serve as Co-Chief of the SEC Enforcement Division’s Asset Management Unit, according to an announcement by the SEC on March 10th. On March 8th, the SEC named Robert M. Fisher as the Managing Executive of its Office of Compliance Inspections and Examinations (“OCIE”).

SEC Opens Registration for National Compliance Outreach Seminar for Investment Companies and Investment Advisers

Compliance personnel at investment companies and investment advisory firms may now register for the SEC’s compliance outreach seminar, according to an announcement on March 9th. The seminar, which will be held on April 19th at the SEC’s Washington, D.C. headquarters, will focus on OCIE’s 2016 priorities, private fund adviser issues, compliance, and rulemaking. SEC Press Release.

SEC Will Pay Almost $2 Million to Three Whistleblowers

The SEC announced on March 8th that it will award three whistleblowers nearly $2 million for information that prompted an investigation of misconduct and ultimately led to a successful enforcement action. The largest award of $1.8 million will be paid to a whistleblower who provided the initial information that sparked the SEC’s investigation as well as additional information throughout the investigation. SEC Release No. 34-77322.

SEC Forms Office of Risk Strategy to Lead National Exam Program

The SEC has formed a new Office of Risk Strategy, which will be housed within OCIE, according to an announcement on March 8th. Peter B. Driscoll will lead the new office in the role of Chief Risk and Strategy Officer and will supervise the risk assessment, market surveillance and quantitative analysis teams.  SEC Press Release.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Chicago Stock Exchange, Inc.

CHX Proposes Changes to Snap Cycle Initiation Process

On March 9th, the SEC requested comments on a proposed rule change filed by the Chicago Stock Exchange, Inc. (“CHX”) that would permit CHX to initiate CHX Snap Cycles without receipt of a valid Start SNAP order in cases where a periodic review of the CHX Books, the SNAP Auction Only Order Queue and Protected Quotations of external markets, in a given security, indicate that the projected execution size would meet certain size and notational value requirements if a SNAP Cycle was initiated. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of March 14, 2016. SEC Release No. 34-77331.

Financial Industry Regulatory Authority

FINRA Reviews Effectiveness of Membership Application Rules

The Financial Industry Regulatory Authority (“FINRA”) published a report on March 11th containing the findings of its review of its rules governing its Membership Application Program, which requires FINRA to evaluate the proposed business activities of potential and current member firms to ensure firms have established financial, operational, supervisory, and compliance systems. The report found that these rules have been effective on the whole. The report also identified areas where effectiveness could be improved, including harmonizing the application review process with the relative risk of the applicant and clarifying the scope and nature of the information to be reviewed.  FINRA Press Release.

FINRA Offers More Guidance on Submission and Feedback Processes for Market Maker Transaction Data

FINRA issued additional guidance on March 8th regarding the procedures for file submission, syntax and semantic processing, linkage processing, and timeframes for submitting a cancel or correction for Market Maker Transaction Data. FINRA Market Maker Transaction Data Supplementary Guidance.

FINRA Updates Research Rules Guidance

FINRA updated its responses to frequently asked questions regarding rules applicable to research analysts on March 4th. The revised guidance includes additional information regarding registration, separation and disclosure requirements. In addition, the FAQs offer additional guidance concerning the exemption for institutional debt research and applicability of  FINRA Rule 5280, which governs trading ahead of research reports. FINRA Research Rules FAQs.


NASDAQ Seeks to Establish Secondary Contingency Procedure for Reporting Official Closing Price

March 7th, the SEC provided notice of a proposed rule change filed by the Nasdaq Stock Market LLC (“NASDAQ”) that would permit NASDAQ to establish a Secondary Contingency Procedure to allow NASDAQ to report an Official Closing Price on behalf of an impaired primary listing exchange.  Under the proposal, NASDAQ would designate NYSE Arca Inc. (“NYSE Arca”) as its official back-up exchange to provide an official closing price in instances where NASDAQ’s market is impaired and unable to execute a closing auction for all or a subset of listed securities. Comments should be submitted on or before April 1, 2016. SEC Release No. 34-77309.

National Futures Association

NFA Will Review and Approve Risk-Based Initial Margin Models for Some SDs and MSPs under CFTC Margin Rules

On March 10th, the National Futures Association (“NFA”) notified members of the NFA’s responsibilities under the Commodity Futures Trading Commission’s (“CFTC”) final margin rules for reviewing and approving risk-based initial margin models for uncleared swaps for CFTC Covered Swap Entities, which include swap dealers not subject to oversight by a prudential regulator. CFTC Covered Swap Entities that elect to use an internal risk-based initial margin model for NFA approval must submit documentation regarding the quantitative and qualitative standards supporting the model and its use to the NFA, with the first compliance date occurring on September 1, 2016. NFA Notice I-16-11.


NYSE Proposes Changes to DMM Interest Designation During Execution of Customer Orders

On March 9th, the SEC requested comments on the New York Stock Exchange LLC’s (“NYSE”) proposed rule change that would provide that when Designated Market Makers (“DMMs”) enter interest on a proprietary basis for the purpose of facilitating the execution of customer orders, such orders would not be required to be designated as DMM interest. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of March 14, 2016. SEC Release No. 34-77332.

NYSE Informs Members of Obligation to Report Certain MRVs to SEC

The NYSE published an Information Memo on March 8th that reminds members of their obligation to report any Minor Rule Violations (“MRVs”) with fines exceeding $2,500 or where the fine was disputed to the SEC on Form BD and Form U-4. The Information Memo noted that unreported MRV fines over $2,500 that were assessed prior to the adoption of current NYSE rules, which prohibit MRV fines in excess of $2,500, should be reported promptly to the SEC. NYSE Information Memo No. 16-03.

NYSE Exchanges Seek SEC Approval of Proposals Regarding Allocation of Data Center Cages

On March 7th, the SEC provided notice of NYSE’sNYSE Arca’s, and NYSE MKT LLC’s (“NYSE MKT”) separately filed proposals to amend their respective rules to establish procedures for the allocation of cages to users of the exchanges, including the waiver of certain fees for users that have requested a cage and have been placed on a waitlist, and to modify the visitor security escort requirements. Comments on the proposals should be submitted on or before April 1, 2016.

NYSE Exchanges Propose Back-Up Procedures for Determining Official Closing Prices When Exchanges Are Impaired

On March 7th, the SEC requested comments on NYSE’s and NYSE MKT’s separately filed proposals that would amend their respective rules to specify back-up procedures for determining an Official Closing Price for securities listed on the exchanges in the event the exchanges are unable to conduct a closing transaction in one or more securities due to a systems or technical issue. Comments should be submitted on or before April 1, 2016.

Industry News

Alleged Architect of Avon and Rocky Mountain Stock Hoaxes Is Arrested

On March 10th, Reuters reported that Nedko Nedev, the alleged architect of hoaxes that drove up the share prices of Avon Products Inc. and Rocky Mountain Chocolate Factory Inc., was arrested in Bulgaria and charged with eight U.S. criminal counts. Nedev was accused of having engineered bogus takeover bids for Avon and Rocky Mountain, and conducted insider trading ahead of a buyout offer for U.S. insurer Tower Group International Ltd. Reuters.

Companies with ‘Insider’ Chairpersons Pay Their CEOs More

According to a report released by Institutional Shareholder Services (“ISS”) on March 9th, companies with “insider” chairpersons actually pay their CEOs 42% more than companies whose board was chaired by an independent “outsider.” CFO noted on March 10th that the ISS report supports calls by shareholder advocacy groups for companies to separate the jobs of chair and CEO, reasoning that a company’s top manager shouldn’t also lead the board that oversees his or her performance and compensation. CFO.