Insights from Winston & Strawn

On April 15th, SEC Chairwoman, Mary Jo White, testified before the House Financial Services Subcommittee to explain the SEC’s fiscal year 2016 budget request of approximate $1.722 billion, and her testimony noted that investment adviser examinations and enforcement remain a priority for the agency. The SEC’s total budget request represents a modest increase from the $1.7 billion requested for the prior fiscal year.

Other priorities highlighted by Chairwoman White in Wednesday’s testimony included expanding the agency’s use of technology, adding to the enforcement division’s investigative and litigation capabilities, bolstering economic and risk analysis functions, and hiring additional market experts.

With respect to examination and compliance activities concerning investment advisers, Chairwoman White said that the SEC’s “current level of resources is not sufficient to permit the SEC to adequately examine investment advisers in a way that investors expect and deserve.” Chairwoman White said that the agency was only able to examine 10 percent of registered investment advisers in the past fiscal year, a level that she noted was low enough that it “presents a high risk to the investing public.” Chairwoman White explained that this year’s budget request would allow the SEC to hire 225 additional investment adviser examiners, which would permit the agency to increase its anticipated annual rate of examination of investment advisers from 10 percent to 14 percent. The budget request also plans for the hiring of 12 new positions in the SEC Division of Investment Management, a portion of whose job responsibilities would entail oversight of private fund advisers, and the hiring of 93 new positions in the Division of Enforcement, covering a variety of areas.

A key area of focus for the SEC’s examination and enforcement activities regarding investment advisers continues to be the disclosure and allocation of fees. Earlier this month, the Wall Street Journal reported that private equity adviser Fenway Partners LLC received a Wells Notice from the SEC regarding Fenway’s treatment and disclosure of fees and expenses charged to its sponsored funds’ portfolio companies. Per a report from PEHub, Kohlberg Kravis Roberts (“KKR”) has recently been in settlement talks with the SEC regarding KKR’s allocation of expenses among certain of its sponsored vehicles, months after it refunded $8 million in fees to its limited partners following an SEC examination. The SEC previously brought and settled charges against Lincolnshire Management for improper allocation of expenses between two of its sponsored funds.

Winston & Strawn LLP will continue to monitor events related to the examination and enforcement actions by the SEC with respect to private equity managers.

John Albers

Feature: Proposed Fiduciary Standard for Retirement Advisors

Last Tuesday, the Department of Labor issued a proposed regulation that would define who is a “fiduciary” of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) as a result of giving investment advice to a plan or its participants or beneficiaries. The proposed definition would also apply to fiduciaries of a plan (including an individual retirement account (“IRA”)) under Section 4975 of the Internal Revenue Code of 1986 (“Code”). The proposed rule replaces a similar proposal made in 2010.

The definition generally covers the following categories of advice: (1) investment recommendations, (2) investment management recommendations, (3) appraisals of investments, or (4) recommendations of persons to provide investment advice for a fee or to manage plan assets. Persons who provide such advice fall within the general definition of a fiduciary if they either (a) represent that they are acting as a fiduciary under ERISA or the Code or (b) provide the advice pursuant to an agreement, arrangement, or understanding that the advice is individualized or specifically directed to the recipient for consideration in making investment or investment management decisions regarding plan assets.

The proposed regulation includes a number of specific carve­outs to the general definition. It distinguishes between fiduciary investment advice and non­fiduciary investment or retirement education. Similarly, the proposal would not treat as fiduciary advice recommendations made to a plan in an arm’s length transaction where there is generally no expectation of fiduciary investment advice, provided that specific conditions are met. In addition, the proposal includes specific carve­outs for advice rendered by employees of the plan sponsor, platform providers, and persons who offer or enter into swaps or security­based swaps with plans. All of the carve­outs are subject to conditions. These carve­outs are intended to allow certain broker­dealers, insurance agents, and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation that otherwise would be prohibited as conflicts of interest.

Under the separately proposed “Best Interest Contract Exemption,” firms would be able to use common fee and compensation practices provided that they adhered to standards aimed at ensuring that their advice is in the best interest of their customers. The exemption requires the firm and the advisor to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice. Central to the exemption is the advisor’s and firm’s agreement to meet fundamental obligations of fair dealing and fiduciary conduct ­ to give advice that is in the customer’s best interest; avoid misleading statements; receive no more than reasonable compensation; and comply with applicable federal and state laws governing advice.

Additionally, the Department separately proposed a new exemption for “principal transactions” in which advisors sell certain debt securities to plans and IRAs out of their own inventory, as well as an amendment to an existing exemption that would permit advisors to receive compensation for extending credit to plans or IRAs to avoid failed securities transactions. In addition to the Best Interest Contract Exemption, the Department requested public comment on whether it should issue a separate streamlined exemption that would allow advisors to receive otherwise prohibited compensation in connection with plan, participant and beneficiary accounts, and IRA investments in certain high­quality low­fee investments, subject to fewer conditions.

In connection with the proposed regulation, the Department has created a webpage with links to the various documents associated with this proposal. Comments on any of the proposals should be submitted within 75 days after publication in the Federal Register, which is expected during the week of April 20. See also Department of Labor Press Release.

Banking Agency Developments

OCC Workshops

The Office of the Comptroller of the Currency (“OCC”) will host two workshops in Birmingham, Alabama for directors of national community banks and federal savings associations. The Risk Governance workshop combines lectures, discussion, and exercises to provide practical information for directors to effectively measure and manage risks. The workshop also focuses on the OCC’s approach to risk­based supervision and major risks in the financial industry. The Compliance Risk workshop combines lectures, discussion, and exercises on the critical elements of an effective compliance risk management program. The workshop also focuses on major compliance risks and critical regulations. OCC Press Release.

OCC Issues Revised Booklets

On April 15th, the OCC issued the “Trade Finance and Services” booklet of the Comptroller’s Handbook. The revised booklet replaces the “Trade Finance” and “Bankers’ Acceptances” booklets, issued in November 1998 and September 1999, respectively. The revised booklet also replaces section 215, “Letters of Credit,” issued in January 1994 as part of the former Office of Thrift Supervision’s Examination Handbook for examining federal savings associations. The “Trade Finance and Services” booklet provides updated examination procedures for examiners concerning trade finance and services activities; highlights the types of products that national banks and federal savings associations may offer in their trade finance and services business lines; and provides information on the risks associated with trade finance and services and supervisory expectations for risk management. OCC Trade Finance and Services Bulletin. On April 14th, the OCC issued the “Real Estate Settlement Procedures Act” booklet of the Comptroller’s Handbook. The revised booklet reflects the transfer of rulemaking authority for Regulation X from the Department of Housing and Urban Development to the Consumer Financial Protection Bureau, new requirements relating to mortgage servicing, new loss mitigation procedures, new prohibitions against certain acts and practices by servicers of federally related mortgage loans with regard to responding to borrower assertions of error and requests for information; and new examination procedures for determining compliance with the new requirements relating to mortgage servicing. OCC RESPA Bulletin.

Amendments to Regulation D Proposed

On April 13th, the Federal Reserve Board requested comment on proposed amendments to Regulation D (Reserve Requirements of Depository Institutions) that make technical changes to the calculation of interest payments on certain balances maintained by depository institutions at Federal Reserve Banks. The Board proposes to amend Regulation D so that interest payments to depository institutions with excess balances are based on the interest paid on excess balances rate (“IOER”) in effect each day and the level of balances held each day, rather than the average IOER rate and average level of excess balances over the maintenance period. Comments should be submitted on or before May 18, 2015. Federal Reserve Board Press Release.

Treasury Department Developments

CFPB Issues TILA Credit Card Submission Rule

On April 15th, the Consumer Financial Protection Bureau (“CFPB”) issued a final rule aimed at improving the way that companies submit consumer credit card agreements to the Bureau. The rule temporarily suspends a requirement that each quarter certain credit card issuers send their agreements to the Bureau, which publishes them in a public database on its website. Other requirements, including card issuers’ obligations to post these agreements on their own publicly available websites, will remain unchanged. The final rule is effective immediately. CFPB Press Release.

CFPB Interpretive Rule on Housing Counselor Requirement

On April 15th, the CFPB issued a final interpretive rule on how to provide mortgage applicants with a list of local homeownership counseling organizations. The interpretive rule restates guidance the CFPB issued in 2013, and provides further guidance for lenders who are building their own lists of housing counselors. The rule also includes guidance on the qualifications for providing high­cost mortgage counseling and for lender participation in such counseling. CFPB Press Release.

Securities and Exchange Commission

Speeches and Testimony

Commissioner Gallagher Addresses Harvard Law School Symposium on Building the Financial System of the 21st Century

On April 15th, Commissioner Daniel M. Gallagher questioned the goals of organizations such as the Financial Stability Board and the Basel Committee. He suggested that instead of “regulatory harmonization,” these groups are attempting to impose a “top­down, forcible imposition of one­size­fits­all regulatory standards on sovereign nations by opaque groups of global regulators.” He called upon these entities to return to their original pre­ financial crisis purposes of facilitating cooperation among regulators from different jurisdictions. And urged them to employ concepts of regulatory equivalence and substituted compliance. Gallagher Remarks.

Commissioner Aguilar Addresses North American Securities Administrators Association Conference

On April 14th, Commissioner Luis A. Aguilar discussed the SEC’s enforcement actions involving complex financial instruments. The SEC’s Complex Financial Instruments Unit (“CFI”) is focusing on structured and new products sold to retail investors, and the Commission expects future enforcement cases regarding those instruments. Relatedly, the SEC’s examination priorities for 2015 will focus on, among other things, registrants that develop new structured products and offer them to retail investors. In addition, Aguilar would like the SEC staff to expand its focus on structured note disclosures to include all complex securities sold to retail investors, engaging state securities regulators and the Financial Industry Regulatory Authority (“FINRA”) in these efforts. Aguilar Remarks.

Commissioner Stein Addresses SIFMA Conference

On April 14th, Commissioner Kara M. Stein discussed the need for new tools to address the increasing use of technology and algorithms in the financial marketplace. She endorsed the use of Legal Entity Identifiers (“LEI”) and the new SEC rules requiring LEIs in security­based swap transactions. She would like that mandate to additionally require the use of LEIs on the table of subsidiaries filed as an exhibit to a company’s annual report. Given the amount of data the SEC is now collecting, Stein would also like the agency to form an Office of Data Strategy which would be overseen by a Chief Data Officer. This new office would ensure a comprehensive approach to data collection, business analysis, data governance, and data standards. Stein Remarks.

Commissioner Gallagher Addresses Virginia Law and Business Review Symposium

On April 10th, Commissioner Daniel M. Gallagher criticized efforts to impose prudential regulation on capital markets. He called the Financial Stability Board’s and Financial Stability Oversight Council’s characterization of asset managers as systemically risky as “nothing more than a ploy to wrest control of a hugely important sector of the capital markets from the SEC.” Gallagher Remarks.

Other Developments

Climate Change Disclosure

On April 17th, Reuters summarized a request submitted by a group of large, institutional investors to the SEC. The group asks the Commission to adopt new rules for the oil and gas industry that would require the disclosure of risks posed to their businesses by climate change. Climate Change Disclosure.

SEC­FINRA Report on National Senior Investor Initiative

On April 15th, the SEC and the Financial Industry Regulatory Authority (“FINRA”) issued a report to help broker­ dealers assess, craft, or refine their policies and procedures for investors as they prepare for and enter into retirement. The report focuses on the types of securities purchased by senior investors, the suitability of recommended investments, training of brokerage firm representatives, marketing, communications, use of designations such as “senior specialist,” account documentation, disclosures, customer complaints, and supervision. Staff from the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) and FINRA are focused on issues related to senior investors and regard compliance with laws, rules, and regulations applicable to senior investors to be a high regulatory priority. SEC Press Release.

EDGAR Updates

The SEC published eight new EDGAR documents.

See also SEC Release No. 33­9746.

Commodity Futures Trading Commission

Congressional Testimony

On April 14th, Bloomberg summarized the testimony of three members of Commodity Futures Trading Commission (“CFTC”) before a House Agriculture subcommittee. The Commissioners discussed the CFTC’s budget and the extent of the agency’s authority. Testimony.

Federal Rules Effective Dates

April 2015 ­ June 2015

Commodity Futures Trading Commission

May 26, 2015             Residual Interest Deadline for Futures Commission Merchants. 80 FR 15507.

Consumer Financial Protection Bureau

April 17, 2015            Submission of Credit Card Agreements Under the Truth in Lending Act (Regulation Z) 80 FR 21153.

Federal Housing Finance Agency

April 10, 2015            Federal Home Loan Bank Capital Stock and Capital Plans. 80 FR 12753.

Federal Housing Finance Board

April 10, 2015            Federal Home Loan Bank Capital Stock and Capital Plans. 80 FR 12753.

Federal Reserve Board

May 15, 2015             Regulations Q, Y, and LL: Small Bank Holding Company Policy Statement; Capital Adequacy of Board­Regulated Institutions; Bank Holding Companies; Savings and Loan Holding Companies. 80 FR 20153.

Foreign Assets Control Office

April 13, 2015            Syrian Sanctions Regulations. 80 FR 19532.

Securities and Exchange Commission

June 15, 2015            Nationally Recognized Statistical Rating Organizations. 79 FR 55077.

[This rule is effective November 14, 2014; except the amendments to Sec. 240.17g­3(a) (7) and (b)(2) and Form NRSRO, which are effective on January 1, 2015; and the amendments to Sec. 240.17g­2(a)(9), (b)(13) through (15), Sec. 240.17g­5(a)(3)(iii)(E), (c)(6) through (8), Sec. 240.17g­7(a) and (b), and Form ABS­15G, which are effective June 15, 2015. The addition of Sec. Sec. 240.15Ga­2, 240.17g­8, 240.17g­9, 240.17g­ 10, and Form ABS Due Diligence­15E are effective June 15, 2015.]

May 18, 2015             Regulation SBSR­Reporting and Dissemination of Security­Based Swap Information. 80 FR 14563.

May 18, 2015             Security­Based Swap Data Repository Registration, Duties, and Core Principles. 80 FR 14437.

Treasury Department

April 3, 2015              Department of the Treasury Acquisition Regulation; Technical Amendments. 80 FR 11595.

Exchanges and Self­Regulatory Organizations

BATS Exchange

Proposed Clarification of System Functionality Approved

On April 16th, the SEC approved BATS Exchange’s proposed amendment of Exchange Rules 11.9, 11.12, and 11.13. The proposal adds additional clarity and specificity regarding the current functionality of the Exchange’s System, including the operation of its order types and order instructions. No substantive modifications to the system are being made. SEC Release No. 34­74738.

The Depository Trust Company

Prospectus Repository System Discontinued

On April 10th, the SEC approved The Depository Trust Company’s (“DTC”) proposed discontinuance of the DTC’s Prospectus Repository System. SEC Release No. 34­74712.

Municipal Securities Rulemaking Board

MSRB Proposes Conduct Rules for Municipal Advisors

On April 15th, the Municipal Securities Rulemaking Board (“MSRB”) announced it has requested SEC approval of proposed Rule G­41, which would establish core standards of conduct for municipal advisors, provide guidance on the obligations and prohibitions that accompany their federal fiduciary duty to state and local governments, and clarify their duties of care and fair dealing to all clients. Among other things, the rule would ban principal transactions with a municipal entity client that are directly related to the transaction for which the municipal advisor is providing advice, require the documentation of an advisory relationship, require written disclosure of conflicts of interest, and require reasonable diligence to support the suitability of recommendations, among other duties. MSRB Press Release.

Financial Industry Regulatory Authority

Firm Element Advisory

On April 10th, the Securities Industry/Regulatory Council on Continuing Education published the Spring 2015 Firm Element Advisory. FINRA Regulatory Notice 15­11. See also FINRA Information Notice.

National Futures Association

NFA Disclosure Guidance

On April 10th, the National Futures Association issued an updated “Proprietary Trading Results” section to its “Disclosure Documents: A Guide to for CPOs and CTAs.”


Longer Period Designated for Consideration of Quote Mitigation Proposal

On April 10th, the SEC designated June 18, 2015 as the date by which it will approve or disapprove NYSE Arca’s and NYSE MKT’s individually submitted proposals to amend their respective rules to remove each of their quote mitigation plans.

Judicial Developments

Suit Over Mismanaged CDO Is Reinstated

On April 15th, the Second Circuit reinstated Financial Guaranty Insurance Co.’s (“FGIC”) claims against Putnam Advisory Co. FGIC alleged Putnam stated it would select the collateral for Pyxis, a collateralized debt obligation (“CDO”) which Putnam managed, independently and in the interests of long investors in order to induce FGIC to provide financial guaranty insurance for Pyxis. But in reality, FGIC claimed, Putnam permitted the collateral selection and acquisition process to be controlled by a third party hedge fund which maintained significant short positions in Pyxis. When the CDO defaulted, FGIC sustained substantial losses. Reversing dismissal, the Court held FGIC had alleged particular facts that, when considered as a whole, plausibly alleged that Putnam’s misrepresentations and omissions caused at least some of the economic harm it suffered. FGIC was not required to establish that the collateral it had identified as selected by a third party was the exclusive cause of its losses; rather, it needed only to allege sufficient facts to raise a reasonable inference that the third party’s involvement caused an ascertainable portion of its loss. Whether intervening events and not Putnam’s actions caused FGIC’s losses is a question of fact which is not determined at the motions stage. The Court further found that FGIC plausibly alleged a special relationship between itself and Putnam sufficient to state claims for negligent misrepresentation and negligence. Financial Guaranty Insurance Co. v. Putnam Advisory Co., LLC.

Constitutional Challenge to SEC Administrative Proceeding Is Rejected

On April 15th, the U.S. District Court for the Southern District of New York held that the SEC’s use of administrative proceedings against persons who are not associated with regulated entities is Constitutional. The SEC filed an administrative enforcement action against Barbara Duka, a former executive of Standard & Poor’s Ratings Services (“S&P”), for fraudulently misrepresenting the manner in which S&P calculated a critical aspect of certain commercial mortgage­backed securities ratings. Duka sought to enjoin the administrative proceeding as an unconstitutional infringement on Presidential oversight. After finding that it has subject matter jurisdiction over the suit, the Court held that Duka was not entitled to a preliminary injunction because she was unlikely to succeed on the merits of her claim. Congressional restrictions on the President’s ability to remove “quasi judicial” administrative law judges are unlikely to interfere with the President’s ability to perform his executive duties. In so finding, the Court distinguished Duka’s claims from those addressed by the Supreme Court in Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 487 (2010). In Free Enterprise, the Supreme Court discussed the Constitutionality of the Public Company Accounting Oversight Board (“PCAOB”). The Supreme Court majority emphasized the PCAOB’s “expansive powers to govern an entire industry” and its “substantial executive authority” typically carried out by officials within the Executive Branch.” The majority expressly excluded ALJs from its holding because “many administrative law judges of course perform adjudicative rather than enforcement or policymaking functions.” Duka v. SEC.

Industry News

Federal Reserve Board Reconsiders Liquidity Rule Requirements

On April 17th, Reuters, covering a Wall Street Journal article, reported the Federal Reserve Board may allow banks to use certain municipal securities to meet liquidity requirements. Liquidity Rule.

Shareholder Appraisal Rights

On April 16th, DealBook published Case Western Reserve law school professor Charles Korsmo’s and Brooklyn Law School assistant professor Minor Myers’s discussion of shareholder appraisal rights, its benefits, and efforts in Delaware to change it. Shareholder Appraisal Rights.

FDIC Vice Chair Discusses Small Bank Regulation

On April 15th, Reuters reported the remarks of the Vice Chair of the Federal Deposit Insurance Corporation, Thomas Hoenig. Hoenig suggested that banks engaged primarily in traditional banking activities should be exempted from some of the Basel III capital requirements and from certain reporting requirements. Hoenig further believes that an exemption from the Dodd­Frank Act’s proprietary trading prohibition for smaller banks is unwise. Hoenig Comments.