Insights from Winston & Strawn

Last week, the Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) issued a risk alert regarding its Multi-Branch Adviser Initiative (the “Risk Alert”). The Risk Alert can be found here. OCIE had originally stated its intent to focus on branch offices as part of its Examination Priorities for 2016 (see here). OCIE is concerned that investment advisers have been using a branch office model on a more frequent basis. By its nature, a branch office is geographically separate from the investment adviser’s principal office and therefore, in the view of OCIE, poses “unique risks and challenges” to the implementation of compliance programs and supervision of personnel by investment advisers. The Risk Alert provides a summary of what OCIE will focus on when examining advisers with branch offices and is a “must read” for all chief compliance personnel at registered investment advisers.

Examinations are expected to focus on a general review of the investment adviser’s compliance program and the investment recommendations made to clients. With regard to the investment adviser’s compliance program, OCIE has stated that it will focus on: (i) the calculation of fees and other expenses and communication regarding the same to clients; (ii) controls over advertisements, particularly those created or disseminated by its branch offices; (iii) implementation of a code of ethics, including oversight and monitoring of personal securities transactions; and (iv) compliance with the SEC’s Custody Rule. With regard to the investment adviser’s recommendations to clients, the OCIE intends to focus on (i) the process by which investment advice, including the formulation of investment recommendations and the management of client portfolios, is provided to clients; (ii) whether the investment adviser is exercising proper controls on the suitability of investment recommendations made to clients and whether personnel have appropriate investment authority; (iii) whether the adviser properly identifies, manages, and discloses conflicts of interest, particularly those surrounding compensation; (iv) whether investment opportunities are properly allocated among client accounts.

This is the final issue of Winston and Strawn’s Financial Services Weekly Update for 2016.  We look forward to picking this up again in 2017. 

On behalf of myself and the entire editorial team, we wish our readers a happy holiday season and a happy, healthy, and prosperous 2017! 

Feature: U.K. FCA Proposes Tougher Rules for Contract for Difference Products

Citing concerns about heightened risks to consumers, the U.K. Financial Conduct Authority (“FCA”) proposed new rules on December 6th that will tighten restrictions for firms selling “contracts for differences” (“CFDs”) and other speculative products, including spread bets and rolling spot foreign exchange products. These complex, leveraged derivative financial instruments promise high returns to investors, but can also result in significant losses. While CFDs have historically been marketed to more sophisticated investors, the number of firms dealing in CFD products in the U.K. has increased dramatically since 2010 along with the number of retail clients. In announcing the proposal, the FCA noted that many of the retail customers now trading in these complex financial instruments lack understanding of how the products work. The FCA’s analysis of client accounts at CFD firms found that 82% of clients lost money.

To address the risks to retail consumers and increasing evidence of poor conduct on the part of investment firms, the FCA proposed a package of measures intended to increase consumers’ understanding of CFDs and limit the risks of these products. Among other things, the proposed measures would:

  1. Introduce standardized risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of these products.
  2. Set lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
  3. Cap leverage at a maximum level of 50:1 for all retail clients and introduce lower leverage caps across different assets according to their risks.
  4. Prevent providers from using any form of trading or account opening bonuses or benefits to promote CFD products.

In proposing the leverage caps for retail clients, the FCA noted that the high levels of leverage currently offered to retail clients—which, in some cases, exceed 200:1—are sometimes combined with the firms’ use of automatic margin close out, which can make it more likely that trades will close at a loss. The FCA also pointed out that many retail investors are attracted by gambling-style promotions, such as account opening bonuses, which makes it less likely that these customers will adequately assess the risks involved with these investments.

Several news agencies reported that CFD firms were caught off guard by the FCA’s proposal, particularly with respect to the proposed leverage caps. Analysts cited by the Financial Times said they were surprised by the proposed leverage limits and said the FCA’s rules could jeopardize growth in the spread-betting sector. Another firm told the BBC that the FCA’s proposal may be less effective at curbing risks if the measures apply only to U.K. firms and not to firms offering CFDs on a cross-border passport from another EU member state. The market effect of the FCA’s proposal on CFD firms was immediate and severe. The Wall Street Journal reported that shares in the U.K.’s largest spread-betting firms lost nearly one-third of their value following the FCA’s announcement.

Other commentators wondered why the FCA delayed proposing stricter regulations for these firms, noting that the U.S. made similar reforms to the regulation of these types of risky investment products almost five years ago. Several other European nations have proposed to ban CFD trading over the last few months. The FCA’s proposal followed news that financial regulators in Cyprus, a key provider of cross-border CFDs in the U.K., had warned the industry about the use of account opening bonuses to attract clients. Just two days after the FCA announced its proposed rules, German regulators unveiled plans to place more restrictions on CFD trading.

The FCA has requested public comments on the consultation paper outlining its proposed restrictions on CFDs. Comments should be received by the FCA on or before March 7, 2017.

Banking Agency Developments


Rules to Reduce Regulatory Burden

On December 15th, the Office of the Comptroller of the Currency (“OCC”) announced its release of the final rule to remove outdated or unnecessary provisions of certain rules to reduce regulatory burden on national banks and federal savings associations.

Revised Comptroller’s Handbook Booklet

On December 14th, the OCC announced that it has issued the “Consigned Items and Other Customer Services” booklet of the Comptroller’s Handbook. This booklet provides updated guidance to examiners assessing the risks associated with consigned items and other customer services.

OCC Releases Review of Efforts to Enhance Large Bank Supervision

On December 13th, the OCC announced its release of a third-party review of its efforts to enhance the agency’s supervision of large and midsize national banks and federal savings associations. The review assessed the OCC’s implementation of recommendations from the 2013 International Peer Review of the agency’s approach to supervising large and midsize institutions.  The assessment, as well as the original 2013 review, was conducted by senior regulators from Australia, Canada, and Singapore along with former staff of the International Monetary Fund.

Rule Expands Number of Banks, Savings Associations Qualifying for 18-Month Exam Cycle

On December 12th, the OCC announced that it, along with the Federal Deposit Insurance Corporation (“FDIC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), issued interagency final rules that increase the number of small banks and savings associations eligible for an 18-month examination cycle rather than a 12-month cycle. The interagency rules are intended to reduce regulatory compliance costs for smaller institutions, while maintaining safety and soundness protections. These rules have been in effect since February 29, 2016, pursuant to the interim final rules previously adopted by the agencies.


Determinations on October Resolution Plan Submissions of Five Systemically Important Domestic Banking Institutions

On December 13th, the FDIC and the Federal Reserve Board announced that Bank of America, Bank of New York Mellon, JP Morgan Chase, and State Street adequately remediated deficiencies in their 2015 resolution plans. 

Federal Reserve

Board Adopts Final Rule to Strengthen Ability of Government Authorities to Resolve Largest Domestic and Foreign Banks Operating in U.S.

On December 15th, the Federal Reserve Board announced that it has adopted a final rule to strengthen the ability of government authorities to resolve in an orderly way the largest domestic and foreign banks operating in the U.S. without any support from taxpayer-provided capital. 

Andreas Lehnert Appointed New Director of Division of Financial Stability

On December 12th, the Federal Reserve Board announced the appointment of Andreas Lehnert as director of its Division of Financial Stability, effective December 25, 2016. Lehnert was involved in implementing the Board’s research and policy agenda on financial stability. Lehnert helped develop and run the Board’s first regulatory stress tests and helped launch the Office of Financial Stability Policy and Research, which later became the Division of Financial Stability.

New Details on How Banking Entities May Seek Extension to Conform Investments in a Narrow Class of Funds That Qualify as ‘Illiquid Funds” to Volcker Rule Requirements

On December 12th, the Federal Reserve Board announced the distribution of additional details regarding how banking entities may seek an extension to conform their investments in a narrow class of funds that qualify as “illiquid funds” to the requirements of section 619 of Dodd-Frank, or the Volcker Rule.

Treasury Department Developments


New Due Date for FBARs

On December 16th, the Financial Crimes Enforcement Network (“FinCEN”) announced that the new annual due date for filing Reports of Foreign Bank and Financial Accounts (“FBAR”) for foreign financial accounts is April 15th.  This date change was mandated by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41, which changes the FBAR due date to April 15th to coincide with the Federal income tax filing season and  mandates a maximum six-month extension of the filing deadline.

FBAR Filing Requirement for Certain Financial Professionals

On December 16th, FinCEN announced further extension of time for certain Report of FBAR filings in light of the notice of proposed rulemaking FinCEN issued on March 10, 2016, which proposes to revise the regulations implementing the Bank Secrecy Act regarding FBARs.  Specifically, one of the proposed amendments would expand and clarify the exemptions for certain U.S. persons with signature or other authority over foreign financial accounts.  This proposed amendment seeks to address questions raised regarding the filing requirement and its application to the individuals with signature authority over, but no financial interest in, certain types of accounts as outlined in FinCEN Notice 2015-1.

Securities and Exchange Commission

Final Rules

SEC Adopts Revisions to EDGAR Filer Manual

On December 9th, the SEC adopted the revised EDGAR Filer Manual, which reflects updates to the EDGAR system related to certain Municipal Advisor and Asset-Back Securities (“ABS”) Issuing Entities submission form types, among other changes. The revised manual will become effective upon publication in the Federal Register.


Investment Management Offers Guidance on Mutual Fund Fee Structures and the DOL’s Fiduciary Rule

On December 15th, the SEC’s Division of Investment Management published a guidance update that discusses disclosure issues and certain procedural requirements with offering variations in mutual fund sales loads and new share classes that may arise as funds respond to the implementation of the Department of Labor’s (“DOL”) rule on conflicts of interest in retirement advice.

No-Action Relief

Investment Management No-Action Letter Clarifies Remuneration for “Affiliated Persons” in FX Transactions

In response to a request by Russell Investment Management LLC, the SEC’s Division of Investment Management issued a no-action letter on December 16th in which it indicated that it would not recommend enforcement action under Section 17(e) of the Investment Company Act if certain registered open-end management investment companies (“Funds”) utilize a broker that is an “affiliated person” of the Funds’ investment adviser to effect foreign currency transactions as agent for the Funds and, for effecting such transactions, receives remuneration within the parameters of Section 17(e)(2).

Trading and Markets Extends Customer Identification Program No-Action Relief to Beneficial Ownership Requirements

In response to a request by the Securities Industry and Financial Markets Association (“SIFMA”), the SEC’s Division of Trading and Markets issued a no-action letter on December 12th in which it indicated that it will not recommend enforcement action if a broker-dealer relies on a registered investment adviser to perform some or all of its obligations under the customer identification program ("CIP") and/or the portion of the customer due diligence rule regarding beneficial ownership requirements for legal entity customers, subject to certain conditions. The Division’s no-action relief extends the effectiveness of a no-action position that it took in 2015 and applies that position to the beneficial ownership requirements until the date upon which an anti-money laundering (“AML”) program rule for investment advisers becomes effective or two years from the date of the no-action letter, whichever is earlier.

Other Developments

DERA White Paper Finds Poor Outcome for Many Investors in OTC Stocks

On December 16th, staff in the SEC’s Division of Economic and Risk Analysis (“DERA”) published a white paper that analyzes certain elements of over-the-counter (“OTC”) stocks, including recent trends in the OTC stock market structure and size; the documented properties of OTC stocks; and the differences in returns based on investor and stock characteristics. The paper concludes that the typical OTC investment return is severely negative and is impacted by associated promotional campaigns, disclosure-related eligibility requirements, and investor demographics.

SEC Approves PCAOB’s 2017 Budget and Accounting Support Fee

At an Open Meeting on December 14th, the SEC voted to approve the Public Company Accounting Oversight Board’s (“PCAOB”) 2017 budget of $268.5 million and accounting support fee, which represents a 4 percent increase from the PCAOB’s 2016 budget. The $268 million support fee will be allocated by assessing $232.6 million on public companies and $35.4 million on broker-dealers. SEC Press Release.  In voting to support the PCAOB’s budget, SEC Chair Mary Jo White noted that it was important that the PCAOB “has adequate funds to fulfill its mission,” but also urged members of the Board to “take a hard look at their funding and expenses to identify possible savings and efficiencies.” In voting against the PCAOB’s budget, SEC Commissioner Michael S. Piwowar emphasized his “concerns about the continued escalation of PCAOB costs.” See also the supporting statement by SEC Commissioner Kara M. Stein.

SEC Approves MIAX PEARL for National Securities Exchange Registration

On December 13th, the SEC approved MIAX PEARL, LLC’s (“MIAX PEARL”) application for registration as a national securities exchange. In the approval order, the SEC indicated that MIAX PEARL does not intend to initially list or trade common stock or non-option securities of operating companies, but will only trade option contracts that meet its options listing standards. SEC Commission Notice 34-79543.

Staff Announcements

The SEC announced on December 12th that it has appointed Dr. Narahari Phatak to serve as Associate Director for Policy in DERA.

EDGAR Updates

On December 12th, the SEC published the EDGAR Form 13F XML Technical Specification (Version 1.3), the EDGAR Form MA XML Technical Specification (Version 1), the EDGAR ABS XML Technical Specification (Version 1.5), the EDGAR Filer Manual (Volume I) General Information (Version 25), and the EDGAR Filer Manual (Volume II) EDGAR Filing (Version 39).

OCIE Announces Examinations of Multi-Branch Investment Advisers

In a Risk Alert published on December 12th, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced that it will launch an initiative to examine the supervisory practices of registered investment advisers over personnel in branch offices. The examinations will focus on evaluating the design and effectiveness of these advisers’ compliance programs and their oversight of advisory services provided at branch offices, with particular emphasis on the implementation of policies and procedures in the main and branch offices; supervision structure; role and empowerment of compliance personnel in branch offices; and the accuracy of information on advisers’ filings regarding branch offices as compared to actual practices. 

DERA White Paper Looks at Effectiveness of Regulation A+

On December 7th, the SEC released a white paper prepared by DERA staff that examines early data on the use of Regulation A+. The paper notes that Regulation A+ securities offerings have surpassed the past rate of Regulation A activity since the amendments became effective, suggesting that Regulation A+ may offer a potentially feasible method for smaller issuers to conduct a public offering and an alternative to other securities offering methods that are exempt from registration under the Securities Act. 

Commodity Futures Trading Commission

No-Action Relief Issued from Inter-Affiliate Exemption from Required Clearing for Affiliated Counterparties Located in Australia or Mexico

On December 15th, the U.S. Commodity Futures Trading Commission’s (“CFTC”) Division of Clearing and Risk announced that it has issued no-action relief to swap market participants to permit a provision of the inter-affiliate exemption from required clearing to be relied upon for swaps executed between certain U.S. swap market participants and their affiliated counterparties located in Australia or Mexico. This relief offers counterparties located in Australia and Mexico the same relief that has been available to counterparties located in the EU, Japan, and Singapore.

Federal Rules Effective Dates

December 2016 – February 2017

Click here to view table. 

Exchanges and Self-Regulatory Organizations

BOX Options Exchange

BOX Proposes to Make Price Improvement Period Pilot Programs Permanent

On December 12th, the SEC requested comments on a proposed rule change filed by BOX Options Exchange LLC (“BOX”) that would amend its rules governing the Price Improvement Period (“PIP”) and Complex Order Price Improvement Period (“COPIP”) to make permanent the pilot programs that permit the Exchange to have no minimum size requirement for orders entered into the PIP and COPIP. Comments should be submitted on or before January 6, 2017. SEC Release No. 34-79531.

Chicago Board Options Exchange

SEC Approves C2’s New Price Protection Mechanisms and Risk Controls

On December 14th, the SEC issued an order approving C2 Options Exchange, Incorporated’s (“C2”) proposal to amend current and adopt new price protection mechanisms and risk controls for orders and quotes to provide additional assistance to brokers in their efforts to prevent errors and avoid trading activity that could potentially be unwanted or disruptive to the market. SEC Release No. 34-79555.

CBOE Proposes Amendments to Rules on Open Outcry Priority and Allocation Requirements

On December 13th, the SEC provided notice of a proposed rule change filed by the Chicago Board Options Exchange Incorporated (“CBOE”) that would amend its rules regarding responsibilities for ensuring compliance with open outcry priority and allocation requirements and Trade-Through prohibitions. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of December 19, 2016. SEC Release No. 34-79540.

CFE Proposes to Broaden Rules on Fraudulent Acts

On December 9th, the SEC requested comments on CBOE Futures Exchange LLC’s (“CFE”) proposal to amend its rules related to fraudulent acts to broaden the rule language and to also prohibit attempts to engage in any fraudulent act or scheme prohibited by the rules. Comments should be submitted on or before January 5, 2017. SEC Release No. 34-79514.

SEC Approves CBOE’s Proposed Amendments to Rules on Opening and Closing Rotations under Hybrid Trading System

On December 9th, the SEC issued an order granting accelerated approval to CBOE’s proposal to amend its rules relating to the opening of series for trading on CBOE’s Hybrid Trading System, which would reorganize and simplify the rules as well as make the rules more accurately reflect current System functionality. The SEC also requested comments on CBOE’s amendment to the proposal. Comments should be submitted on or before January 5, 2017. SEC Release No. 34-79520.

Depository Trust Company

SEC Approves Clearing Agencies’ Proposed Investment Policy

On December 12th, the SEC granted accelerated approval to proposals by The Depository Trust Company (“DTC”), the Fixed Income Clearing Corporation (“FICC”), and the National Securities Clearing Corporation (“NSCC”) to adopt the Clearing Agency Investment Policy, which governs the investment of funds of the Clearing Agencies. The SEC also requested comments on an amendment to the proposals, which makes a technical correction to the proposed Cleary Agency Investment Policy. Comments should be submitted on or before January 3, 2017. SEC Release No. 34-79528.

Financial Industry Regulatory Authority

FINRA Provides Schedule for 2017 Holiday Trade Date, Settlement Date, and Margin Extensions

In an Information Notice published on December 14th, the Financial Industry Regulatory Authority (“FINRA”) released a schedule of trade date, settlement date, and margin extensions for 2017 holidays to assist brokers, dealers, and municipal securities dealers in making requests for extensions of time for “regular way” transactions effected on dates prior to and after a holiday when the exchanges are closed.

FINRA Report Offers Snapshot of U.S. Investors

On December 13th, FINRA published the findings of its Investors in the United States 2016 report, which examined the responses of 2,000 people who hold investments in non-retirement accounts. The report found that over half of respondents use a financial professional to improve investment performance, avoid losses, and learn about investments, but investors’ understanding of investment concepts is low. FINRA Press Release.

International Securities Exchange

ISE Exchanges Propose To Make PIM Pilot Program Permanent

On December 13th, the SEC requested comments on ISE Gemini LLC’s (“ISE Gemini”) and ISE Mercury LLC’s (“ISE Mercury”) separately filed proposals to amend their respective rules to make permanent aspects of their Price Improvement Mechanisms (“PIM”) operating on a pilot basis, including the termination of the exposure period by unrelated orders and no minimum size requirement of orders eligible for PIM. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of December 19, 2016.

ISE Seeks To Make Permanent PIM Pilot Program

On December 12th, the SEC requested comments on the International Securities Exchange LLC’s (“ISE”) proposal to amend its rules concerning its PIM to make permanent certain components of the pilot program, including the termination of the exposure period by unrelated orders and no minimum size requirement of orders eligible for PIM. Comments should be submitted on or before January 6, 2017. SEC Release No. 34-79530.

International Swaps and Derivatives Association

ISDA Research Note Takes Closer Look at IRD Clearing and SEF Trading

On December 15th, the International Swaps and Derivatives Association (“ISDA”) published Trends in IRD Clearing and SEF Trading, a research note that analyzes the dynamics of US swap execution facility (“SEF”) trading by looking at cleared interest rate derivatives (“IRD”) data and analyzing which products are traded on a SEF and which are not.


SEC Takes More Time to Consider Nasdaq’s Proposed Retail Post-Only Order

On December 14th, the SEC designated January 30, 2017, as the date by which it will approve, disapprove, or institute disapproval proceedings regarding The Nasdaq Stock Market LLC’s (“Nasdaq”) proposal to adopt a new Retail Post-Only Order. SEC Release No. 34-79554.


NYSE Reminds Firms of Surveillance Obligations

In an Information Memo released on December 15th, the New York Stock Exchange LLC (“NYSE”) reminded members of their obligations to use available tools to monitor and address trading or quoting activity that improperly disrupts the trading of securities, including FINRA’s Cross-Market Equities Supervision—Potential Manipulation Reports (“Report Cards”). Members who fail to use the Report Cards as an informational tool to supplement their own surveillance of customer trading activity and who fail to halt customers’ disruptive activity risk disciplinary action or suspension.

Judicial Developments

Employee Who Fraudulently Solicited Investments for Employer Is Liable for Investors’ Losses, Despite Not Being Charged with Knowledge of Ponzi Scheme

While soliciting investments for his employer, defendant falsely told investors he had experience managing investments and personally invested in his employer’s promissory notes. Following a conviction, and despite not alleging defendant knew of his employer’s Ponzi scheme, the government sought to hold him accountable for the $3.3 million in investor losses. The district court enhanced the sentence and ordered restitution and forfeiture based on the victims’ total loss. On December 12th, the Seventh Circuit affirmed the conviction but remanded for recalculation of the sentence, restitution order, and forfeiture order. United States v. John T. Burns, III.

Industry News

Apple’s Board Relaxes Rules for Director Nominations by Outside Investors

On December 16th, Reuters reported that Apple Inc.’s board relaxed some rules for director nominations by outside investors, but refused to submit to broader changes sought by an activist shareholder. The new bylaws revealed in a securities filing this week dealt with the “proxy access” process, which allows outside investors to nominate their own candidates to a company’s board.

Big Banks Turn to Supreme Court on Fight Against Financial Crisis-Era Lawsuits

On December 13th, The New York Times reported that big banks have asked the Supreme Court to review a lower court decision that regulators filed their financial crisis-era claims on time despite the Securities Act of 1933, which gives them only a three-year window. Wells Fargo, Credit Suisse, Deutsche Bank and others argued that the regulators took too long to file their claims. The Justice Department asked the Court not to take up the case, saying that the banks’ argument lacks merit.

Despite Republican Requests, SEC Chair White Will Continue Adopting New Rules

On December 12th, Reuters reported that SEC Chair Mary Jo White disregarded requests by Senate Republicans to stop adopting new rules until after Trump takes office and has a chance to review the SEC’s agenda. In a letter to the Senate Banking Committee’s top two Republicans, Chairman Richard Shelby and Mike Crapo of Idaho, White noted that it is “incumbent” on the agency to “exhibit a spirit of firm independence” in performing its regulatory duties “without fear or favor.” New rules expected to be adopted before Trump takes office include those on derivatives and mutual funds.