Insights from Winston & Strawn Feature: SEC Approves PCAOB’s New Standard Requiring New Disclosures in the Auditor’s Report Banking Agency Developments Treasury Department Developments Securities and Exchange Commission Commodity Futures Trading Commission Federal Rules Effective Dates Exchanges and Self-Regulatory Organizations Winston & Strawn Upcoming Events & Speaking Engagements Winston & Strawn Publications VOLUME 12, NO. 41 October 30, 2017 Insights from Winston & Strawn On October 16, 2017, the Securities and Exchange Commission (“SEC”) issued a no-action letter related to credit risk transfer securities used as investments for private funds claiming exception from registration as investment companies under Section 3(c)(5)(C) (the “Real Estate Exception”) of the Investment Company Act of 1940 (“ICA”). This no-action letter has the effect of allowing the treatment of credit risk transfer securities as real estate-type interests for the purposes of the Real Estate Exception. The Real Estate Exception excludes from the definition of an investment company any person that is “primarily engaged in [the business of]… purchasing or otherwise acquiring mortgages and other interest on and interests in real estate.” The SEC staff has interpreted that the exception provided in this section of the ICA may be available to an issuer if the following conditions are met: At least 55% of the issuer’s assets are “qualifying interests” (mortgages and other liens on and interests in real estate) and the remaining 45% of the issuer’s assets are primarily “real estate-type interests”; At least 80% of the issuer’s total assets are “qualifying interests” or “real estate-type interests”; and At most, 20% of the issuer’s total assets have no relationship to real estate. According to the no-action letter, credit risk transfer securities are securities that “effectively transfer to institutional investors a portion of the credit risk of mortgage pools that are owned by Fannie Mae or Freddie Mac or that back MBS whose timely principal and interest payments are guaranteed by Fannie Mae or Freddie Mac.” Such securities have the following common characteristics: “ (1) the payment of the stated principal and interest on such securities is not guaranteed; (2) the performance of the securities is designed to simulate the delinquency and principal payment experience of a designated reference pool of mortgages that are owned by Fannie Mae or Freddie Mac or that back specified Fannie Mae- or Freddie Mac-guaranteed MBS; (3) their payments are not derived directly from mortgage cash flows; (4) the securities are not secured by and do not represent a direct ownership interest in mortgages; and (5) ownership does not empower investors to control the servicing of, or foreclose on, any of the pooled mortgages.” While the SEC staff has taken the position that securities of another issuer engaged in the real estate business are not qualifying interests, the staff has indicated that certain mortgage-related instruments may be treated as real estate-type interests. Accordingly, in the no-action letter, the SEC staff concluded that credit risk transfer securities, as described above, qualify as “real estate‑type interests,” and therefore a fund relying on the Real Estate Exception may invest up to 45% of its assets in such securities. John P. Alexander Feature: SEC Approves PCAOB’s New Standard Requiring New Disclosures in the Auditor’s Report Last week, the Securities and Exchange Commission (“SEC”) approved a proposal submitted by the Public Company Accounting Oversight Board (“PCAOB”) that would make substantial changes to the report submitted by an auditor following an audit of an issuer’s financial statements. The new rules, which represent the first significant change to the standard auditor’s report in 70 years, aim to increase transparency and make the report more informative to investors by requiring auditors to disclose new information about the audit Under the new rules, the PCAOB will adopt a new auditing standard on the auditor’s report and make related amendments to other auditing standards. The new auditing standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, will still communicate a pass/fail opinion currently used in the auditor’s report, but will also require auditors to disclose any critical audit matters (“CAMs”) from the audit. A CAM would include any matter that the auditor communicated to the audit committee related to accounts or disclosures considered material to the financial statements and that involved especially challenging, subjective, or complex auditor judgment. Auditors will be required to take into account certain factors when making a CAM determination, including the risks of material misstatement and the nature and timing of unusual transactions. The rules include other changes to the auditor’s report to provide additional information about the auditor’s role and responsibilities, including statements on the auditor’s tenure and independence. The SEC unanimously approved the changes to the auditor’s report. SEC Chairman Jay Clayton said that he “strongly support[s] the objective of the rule to provide investors with meaningful insights into the audit from the auditor.” Commissioner Michael S. Piwowar noted that the new rules aim “to improve communication of the most critical audit matters by external auditors to company management and audit committees.” Emphasizing the benefits of the new disclosures to investors, Commissioner Kara M. Stein maintained that “the new information from the auditor will add to the total mix of information available to investors when making voting and capital allocation decisions.” Stein’s position was shared by advocates for transparency who pushed for the new rules as a way to help investors understand potential risks. Organizations representing accountants also welcomed the new standard as a way to improve audits for the benefit of investors and capital markets. The new standard faced opposition from the business community, which objected to the proposal on the grounds that the changes would confuse investors and increase costs for companies. Chairman Clayton acknowledged concerns raised by commenters on the proposal who argued that the new standard could lead to more litigation, result in boilerplate rather than meaningful disclosure, and chill communications between auditors and the audit committee. Clayton said that “he would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships.” Clayton and Piwowar both urged careful implementation of the new standard to address these concerns, and Clayton encouraged the PCAOB to consider making any necessary changes to the rules based on the results of its post-implementation review. Analysts at the Corporate Counsel Blog observed that the new auditor’s report will be “fundamentally different” going forward, concluding that “the SEC didn’t just pare back the boilerplate – it blew up the boiler. Time will tell if anybody gets scalded.” The new standards will apply to audits of large accelerated filers beginning in 2019, and for audits of all other companies subject to the rules beginning in 2020. The disclosure of auditor tenure will become effective sooner, with that information appearing in audits of fiscal years ending on or after December 15, 2017. Banking Agency Developments OCC OCC Seeks Comment on Proposed Technical Changes to Annual Stress Test Rule On October 27th, the Office of the Comptroller of the Currency (“OCC”) announced that it is seeking comment on a notice of proposed rulemaking amending its Annual Stress Test rule. The proposed changes would make several technical revisions to the stress testing regulation. Comments on the proposal will be accepted for 60 days from the date of publication in the Federal Register. OCC to Host Building Blocks for Directors Workshop in New Mexico On October 23rd, the Office of the Comptroller of the Currency (“OCC”) announced that it will host a Building Blocks for Directors workshop in Albuquerque, N.M., at the Crown Plaza Albuquerque, December 4-6. The workshop will focus on duties and core responsibilities of directors and management, discuss major laws and regulations, and increase familiarity with the examination process. This is the final Building Blocks for Directors workshop scheduled for 2017. Liquidity Coverage Ratio: Interagency FAQs On October 23rd, the OCC, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, announced their release of answers to frequently asked questions regarding the liquidity coverage ratio rule. New, Modified, or Expanded Bank Products and Services: Risk Management Principles On October 20th, the OCC published a bulletin informing banks, federal savings associations, and federal branches and agencies of foreign banks of the principles they should follow to prudently manage the risks associated with offering new, modified, or expanded products and services. Federal Reserve In Appointing Possible Yellen Replacement, Trump Sets to Shift Federal Reserve President Trump may upset years of consistency at the Federal Reserve in his appointment of its next leader. According to The Washington Post on October 20th, Trump’s final list of candidates, which includes current Chair Janet L. Yellen herself, also includes Stanford professor John Taylor and former Fed governor and Republican economic official Kevin Warsh, both of whom have repeatedly attacked the Fed’s approach to keeping interest rates low in hopes of stimulating the economy. Trump’s decision, which could garner extensive consequences for the economy, is set to be announced before November 3rd. CFPB Senate Votes to Strike Down CFPB Class-Action Rule On October 24th, Senate Republicans voted to overturn a new Consumer Financial Protection Bureau (“CFPB”) rule that would have permitted millions of Americans to join class-action lawsuits against financial institutions. According to The New York Times, the Senate’s action will further loosen regulation of Wall Street since the CFPB rule, which was to take effect in 2019, would have potentially exposed financial firms to a flurry of costly lawsuits over dubious business practices. On October 23rd, the U.S. Treasury Department had released a report that the CFPB failed to adequately evaluate the harm the rule could have caused to consumers. Treasury Department Developments U.S. Treasury Wants to Do Away with the Term ‘Shadow Banking.’ On October 27th, Bloomberg reported that the U.S. Treasury Department wants global regulators to stop using the term “shadow banking” when describing investment firms, because “[t]he word ‘shadow’ could be interpreted as implying insufficient regulatory oversight, or disclosure.” In an October 26th report promoting an easing of restrictions on asset managers and insurers, the Treasury Department added that the use of the term is “particularly inappropriate” for investment companies that are supervised by the SEC and file routine reports to the agency. The Treasury offered an alternative term: “market-based finance.” Securities and Exchange Commission Final Rules SEC Finalizes Rule Amendments to Exempt IEX-Listed Securities from State Registration Requirements The SEC issued a final rule on October 24th that amends Rule 146 under Section 18 of the Securities Act to designate certain securities listed on Investors Exchange LLC (“IEX”) as covered securities for purposes of Section 18(b), which would exempt these securities from state law registration requirements. The final rule also amends Rule 146 to reflect changes to the names of some exchanges. The rule will become effective 30 days following publication in the Federal Register. No-Action Relief and Exemptive Orders SEC Staff Issues Three Related No-Action Letters to Enable Cross-Border Implementation of the Research Provisions of the EU’s MiFID II On October 26th, after consulting with EU authorities and, as SEC Chair Jay Clayton commented, “to reduce confusion and operational difficulties that might arise in the transition to MiFID II’s research provisions,” SEC staff issued three related no-action letters in an effort to give market participants more certainty as to their U.S. regulated activities when engaging in efforts to comply with the EU’s Markets in Financial Instruments Directive (“MiFID II”) ahead of its Jan. 3, 2018, effective date. Pursuant to the no-action relief, market participants will be able to comply with MiFID II’s research requirements in a way that is consistent with US federal securities laws. Under the first no-action letter, broker-dealers may temporarily receive research payments from money managers in cash or from advisory clients’ research payment accounts. Under the second no-action letter, money managers may continue to aggregate orders for mutual funds and other clients. Under the third noaction letter, money managers may continue to rely on an existing safe harbor when paying broker-dealers for research and brokerage. Clayton noted that these letters “…take a measured approach in an area where the EU has mandated a change in the scope of accepted practice, and accommodate that change without substantially altering the U.S. regulatory approach.” He continued, “[t]hese steps should preserve investor access to research in the near term, during which the Commission can assess the need for any further action.” Division of Investment Management Denies Adviser’s Proposed Expense Allocation No-Action Request On October 26th, the SEC’s Division of Investment Management denied adviser Mutual of America Capital Management LLC’s request for a no-action recommendation if it allocates certain operating expenses of a fund for which it serves as investment adviser (a “fund of funds”) to other funds also advised by it (“underlying funds”) without first obtaining an SEC order under Investment Company Act of 1940, Rule 17d-1 permitting such allocation. Speeches and Statements Stein Objects to MiFID II No-Action Relief In response to SEC staff’s decision on October 26th to issue no-action relief to certain market participants to comply with the research requirements of MiFID II, SEC Commissioner Kara M. Stein issued a statement in which criticized the no-action relief because it fails to address issues of transparency and investor protection associated with the practice of bundling research payments with trading commissions and other fees. Stein also objected to the SEC’s plan to study the impact of MiFID II for 30 months and called on the SEC “to consider timely notice and comment rulemaking in order to reach the best policy outcome in this area.” Avakian Discusses New Enforcement Initiatives at Securities Enforcement Forum Speaking at the Securities Enforcement Forum 2017 on October 26th, SEC Division of Enforcement Co-Director Stephanie Avakian discussed the SEC’s new Retail Strategy Task Force and Cyber Unit to highlight how the SEC is allocating its resources to address its key priorities of protecting retail investors and confronting threats posed by cyber-related issues. Peikin Suggests SEC May Abandon “Broken Windows” Enforcement and Mandatory Admissions On October 26th, the Wall Street Journal reported that the SEC may abandon its “broken windows” approach to enforcement and mandatory admissions of wrongdoing, based on remarks at the Securities Enforcement Forum by Steven Peikin, Co-Director of the SEC’s Division of Enforcement. According to the article, Peikin signaled that the SEC, which faces budget constraints, may have to be more selective in the cases it pursues. Piwowar Discusses Past and Future Market Structure Initiatives in Conference Remarks In remarks at the Financial Industry Regulatory Authority (“FINRA”) and Columbia University Market Structure Conference on October 26th, SEC Commissioner Michael S. Piwowar discussed the SEC’s past initiatives to address market structure issues and the direction the SEC will take in its ongoing review of market structure, including plans for a transaction fee pilot and the formation of a new advisory committee on fixed income market structure. Clayton Discusses Data Security, Fiduciary Rule at SIFMA Conference Speaking at the Securities Industry and Financial Markets Association (“SIFMA”) annual conference on October 24th, SEC Chairman Jay Clayton discussed efforts by the SEC to increase data security and make more efficient use of data for targeting potential violations during examinations, according to a report in Law360. Investment News reported that Clayton expressed his commitment to developing a fiduciary standard for investment advice, but emphasized that the SEC must work with the Department of Labor (“DOL”) and respect “their process.” Other Developments SEC Plans New Advisory Committee on Fixed Income Market Structure The SEC provided notice on October 26th that it intends to establish the Fixed Income Market Structure Advisory Committee, which will advise the SEC on the structure and operations of the U.S. fixed income markets. The SEC has invited the public to submit comments on the plans for the new committee. Staff Announcements The SEC announced on October 26th that it has appointed Peter B. Driscoll to serve as the Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). Driscoll has served as the Acting Director of OCIE since the beginning of the year. SEC Joins Government in Brief Supporting Whistleblower in Anti-Retaliation Suit On October 24th, the SEC published an amicus curiae brief that the U.S. Solicitor General filed in Digital Realty Trust Inc. v. Paul Somers, a wrongful termination lawsuit before the U.S. Supreme Court. Joining the brief in support of Somers, the SEC argued that the Court should interpret the anti-retaliation provisions of Section 21F(h)(1) of the Securities Exchange Act to extend to any individual who reports suspected violations internally or to government authorities, regardless of whether the individual makes a separate report to the SEC. The SEC maintained that this interpretation, which it adopted in Securities Exchange Act Rule 21F-2(b)(1), reflects the most reasonable construction of the relevant statutory language, is entitled to deference as a permissible construction of that language, and encourages internal reporting of potential wrongdoing in appropriate circumstances, which supports the overall objective of the whistleblower rule. DERA Staff Publishes Analysis of Investor Confidence On October 23rd, Staff in the SEC’s Division of Economic and Risk Analysis (“DERA”) published an economics note that sets out a framework for understanding investor confidence. The note analyzes investors’ optimism about the “fundamental” risk and return of their investments and their trust in protections provided to investors in financial markets against potential losses, and considers the dynamics and measurement of investor trust. Commodity Futures Trading Commission Order Extends Current Swap Dealer De Minimis Threshold to December 2019 On October 26th, the Commodity Futures Trading Commission (“CFTC”) announced that it has issued an Order that will keep the swap dealer de minimis threshold at $8 billion until December 2019. This one-year extension will give the CFTC additional time to complete the current data analysis and for the agency to consider appropriate further action. Federal Rules Effective Dates October 2017 – December 2017 Consumer Financial Protection Bureau October 19, 2017 Mortgage Servicing Rules Under the Real Estate Settlement Procedures Act (Regulation X). 82 FR 47953. Amendments to the 2013 Mortgage Rules Under the Real Estate Settlement Procedures Act (Regulation X) and the Truth in Lending Act (Regulation Z). 81 FR 72160. Amendments to the 2013 Mortgage Rules Under the Real Estate Settlement Procedures Act (Regulation X) and the Truth in Lending Act (Regulation Z); Correction. 82 FR 30947. October 1, 2017 Prepaid Accounts Under the Electronic Fund Transfer Act (Regulation E) and the Truth In Lending Act (Regulation Z). 81 FR 83934. Amendments to Federal Mortgage Disclosure Requirements Under the Truth in Lending Act (Regulation Z). 82 FR 37656. Federal Deposit Insurance Corporation October 1, 2017 Recordkeeping Requirements for Qualified Financial Contracts. 82 FR 35584. Federal Financial Institutions Examination Council November 24, 2017 Collection and Transmission of Annual AMC Registry Fees. 82 FR 44493. October 2, 2017 Description of Office, Procedures, and Public Information. 82 FR 45697. Federal Reserve System November 24, 2017 Rules Regarding Availability of Information (Federal Reserve System). 82 FR 49286. November 13, 2017 Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions. 82 FR 42882. November 1, 2017 Rules Regarding Availability of Information (Federal Open Market Committee). 82 FR 45679. Treasury Department November 27, 2017 Changes to the In-Bond Process. 82 FR 45366. November 13, 2017 Nondiscrimination on the Basis of Age in Programs and Activities Receiving Federal Financial Assistance From the Department of the Treasury. 82 FR 47107. October 11, 2017 Department of the Treasury Employee Rules of Conduct. 82 FR 47105. Exchanges and Self-Regulatory Organizations Chicago Stock Exchange SEC Presses Pause on CHX’s Speed Bump The Wall Street Journal reported on October 25th that the SEC has stayed a decision by staff in its Division of Trading and Markets to approve the Chicago Stock Exchange’s (“CHX”) planned “speed bump.” According to the article, SEC Commissioner Michael S. Piwowar objected to CHX’s proposal because it gave CHX a “protected quote,” which he believes should not be available to exchanges that implement speed bumps. Financial Industry Regulatory Authority FINRA Educates Investors about Risks of Volatility-Linked ETPs In an Investor Alert published on October 26th, FINRA advised investors to educate themselves about the risks associated with volatility-linked exchange-traded products (“ETPs”) before investing. The Alert emphasizes the need for investors to understand how these products work and how their structure differs from other ETPs. FINRA’s Axelrod Announces Departure Plans On October 26th, FINRA announced that Susan F. Axelrod, the Executive Vice President for Regulatory Operations, plans to leave FINRA at the beginning of 2018 to pursue a career in the private sector. Axelrod has served in various capacities at FINRA and its predecessor, NYSE Regulation, for 28 years. FINRA Announces Plans for Annual Cybersecurity Conference On October 23rd, FINRA announced that it will hold its 2018 Cybersecurity Conference on February 22, 2018, in New York City. The conference will focus on preparing organizations to understand and respond to cyber vulnerabilities and threats. FINRA Notifies Firms of Upcoming Elections FINRA notified firms on October 20th that it will hold elections to fill vacancies on the FINRA District Committees, an open small firm seat on the National Adjudicatory Council, and one North Region and one South Region representative to the Small Firm Advisory Board. Ballots for all elections should be submitted on or before November 20, 2017. Municipal Securities Rulemaking Board MSRB Proposes Additional Data Reporting Requirements for Underwriters of ABLE Programs and 529 Plans On October 23rd, the SEC requested comments on a proposed rule change filed by the Municipal Securities Rulemaking Board (“MSRB”) that would require dealers acting as underwriters to 529 college savings plans or to programs established to implement the Stephen Beck, Jr., Achieving a Better Life Experience Act of 2014 (“ABLE”) to collect and report additional data about the transactional fees and expenses assessed by ABLE programs or 529 plans. Comments should be submitted on or before November 17, 2017. SEC Release No. 34-81921. NYSE SEC Delays Action on NYSE’s Proposal on End-of-Day News Releases On October 20th, the SEC designated December 4, 2017, as the date by which it will approve, disapprove, or institute disapproval proceedings concerning the New York Stock Exchange LLC’s (“NYSE”) proposal to amend the NYSE Listed Company Manual to prohibit listed companies from issuing material news after the official closing time for NYSE’s trading session until the publication of such company’s official closing price on NYSE or five minutes after the official closing time, whichever is earlier. SEC Release No. 34-81914. Options Clearing Corporation OCC Submits Proposal on Default Management Policy On October 26th, the SEC provided notice of a proposed rule change filed by The Options Clearing Corporation (“OCC”) that would formalize and update OCC’s Default Management Policy, which outlines OCC’s default management framework and describes the default management steps that OCC has authority to take depending upon the facts and circumstances of a default. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of October 30, 2017. SEC Release No. 34- 81955. OCC Proposes Rule Changes Related to Liquidity for Same Day Settlement On October 26th, the SEC requested comments on a proposed rule change filed by OCC that would revise OCC’s By-Laws to expand upon existing authority to borrow against the Clearing Fund in an effort to address situations where OCC faces a liquidity need to meet its same-day settlement obligations as a result of a bank or securities or commodities clearing organization failing to achieve daily settlement. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of October 30, 2017. SEC Release No. 34-81956. OCC Proposes to Adopt Counterparty Credit Risk Management Policy On October 26th, the SEC requested comments on OCC’s proposal to formalize its Counterparty Credit Risk Management Policy, which outlines OCC’s overall approach to identify, measure, monitor, and manage its exposures to counterparties arising from its payment, clearing, and settlement processes. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of October 30, 2017. SEC Release No. 34-81949. Winston & Strawn Upcoming Events & Speaking Engagements The Real Deal Webinar Series: Delaware Law Developments/Recent Judicial Decisions Affecting M&A Transactions and Corporate Governance—Part 2 As part of The Real Deal webinar series, Winston & Strawn will present “Delaware Law Developments/Recent Judicial Decisions Affecting M&A Transactions and Corporate Governance—Part 2” on December 14, 2017 from 12:00-1:15 p.m. (CDT). Webinar. Winston & Strawn Publications Antitrust and Competition – The EU Weekly Briefing, Vol 5, Issue 40 The EU Weekly Briefing is designed to provide timely updates on recent European Union competition law by including a short description of, and links to, recent developments. Newsletter. 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