Insights from Winston & Strawn

Conference with SEC Regulators

Practising Law Institute held its 2016 “The SEC Speaks” conference last week, featuring a number of presentations from, and discussions with, high-ranking members of the U.S. Securities and Exchange Commission (SEC), including Chair Mary Jo White, Commissioner Kara Stein, Stephanie Avakian, the Deputy Director for the Division of Enforcement and Lara Shalov Mehraban, the Associate Regional Director for Enforcement for the New York office.

Chair White indicated that the SEC will prioritize work in the areas of asset management, equity market structure, and disclosure effectiveness in 2016. White stated that she expected the SEC to (a) finalize rules regarding (i) supervision of proprietary traders and (ii) alternative trading systems; (b) improve disclosures related to order routing; (c) increase the effectiveness of risk management over trading algorithms, (d) work towards establishing a centralized repository to track and audit trade orders. For the asset management industry in particular, White emphasized the need for the SEC to make significant progress on transition planning and stress testing proposals. A transcript of Chair White’s remarks can be found here.

Speaking separately, Commissioner Stein highlighted the dangers that she saw in regulating exchange-traded funds (ETFs) similar to traditional equity securities. Stein cited to specific instances last fall when the market in general was volatile, but in which she characterized ETFs as being unpredictable as they “experienced greater increases in volume and more severe volatility than corporate stocks.” Commissioner Stein suggested that the SEC should consider a “holistic” review of ETFs, evaluating the manner in which ETFs are marketed and their suitability among different types of investors, ETFs’ general correlation to the market and the level and accuracy of disclosures made. A transcript of Commissioner Stein’s remarks can be found here.

Continuing the SEC’s focus on cybersecurity, Deputy Director Avakian took part in a panel discussion in which she discussed the two primary areas of focus for the Enforcement Division so far – (1) penalizing firms that have failed to create appropriate safeguard to protect client data (this statement was echoed by Associate Director Mehraban), and (2) in coordination with the Department of Justice, pursuing hackers and traders that actively try to obtain client data or access information that will provide a competitive advantage in the market. While stories about the security, or lack thereof, of personally identifiable client data have become commonplace in the market, Avakian also relayed a story of traders and hackers actually teaming together in order to gain access to, and trade on, information ahead of general market dissemination.

Associate Director Mehraban focused on the potential liability of the boards of directors of financial institutions, noting that the SEC didn’t believe that it was their job to Monday morning quarterback decisions made in good-faith, but to instead pursue significant cases where the board had failed in its duty of oversight. While the general statements were positive, Ms. Mehraban did nothing to allay the concerns that the SEC has targeted, and likely will continue to target, directors in their individual capacity for enforcement actions. For additional information and guidance that may be useful for financial institution directors, please consider participating in Winston and Strawn’s Financial Institution Directors Webinar series which brings together leading attorneys, regulators, and directors to discuss important and topical issues.

Feature: Wall Street Whistleblowers and the Bank Whistleblowers United

In January 2016, Senator Elizabeth Warren published a report entitled, Rigged Justice: 2016 – How Weak Enforcement Lets Corporate Offenders Off Easy, which is a condemnation of a system that she says allows corporate criminals to go free while those without the same power and influence are severely punished. Senator Warren’s report cites 20 civil and criminal cases from 2015 “in which the federal government failed to require meaningful accountability.” Senator Warren, who has clashed with the SEC and SEC Chair Mary Jo White, singles out the SEC as “particularly feeble,” letting corporate offenders off the hook with weak civil settlements and then consistently granting the wrongdoers waivers from automatic penalties triggered by the violations. Senator Warren discussed her report in an op-ed in The New York Times on January 29th, observing that “[e]nforcement isn’t about big government or small government … It’s about whether government works and who it works for.”

On February 1st, the Government Accountability Project (“GAP”) released a white paper prepared for the SEC entitled, Why Whistleblowers Wait: Recommendations to Improve the Dodd-Frank Law’s SEC Whistleblower Awards Program. This report warns that arbitrary rulings could discourage disclosures by convincing possible whistleblowers that the SEC’s “award system neither offers proportional incentives that overcome the risks of disclosure, nor is grounded in the reality whistleblowers face…” The report is a comprehensive study of the issues that whistleblowers encounter when they challenge corporate misconduct, and the dangers of compelling them to file hurried reports.

GAP’s report warns that “[t]he importance of timely whistleblowing disclosures is beyond dispute. But equally important are safe, responsible disclosures for the most effective government action … Policies that increase reprisal risks while encouraging ‘quick and dirty’ disclosures will be a ‘lose-lose-lose’ result for whistleblowers, the SEC whistleblower program, and corporate employers. The SEC can and should prevent that outcome through clear guidance that balances its recent actions on delay.”

Perhaps a result of the lack of SEC guidance on how to meet its whistleblower report requirements, Wall Street whistleblowers claim that they are routinely snubbed or even fired and blackballed from the industry. In addition, it is alleged that the wrongdoing that the whistleblowers witnessed and reported is frequently covered up. Four former whistleblowers, Gary J. Aguirre, William K. Black, Richard M. Bowen III, and Michael Winston have formed Bank Whistleblowers United, which is a pro bono group and policy initiative that seeks to improve the status of Wall Street whistleblowers and change the way in which Wall Street is regulated.

Bank Whistleblowers United says that their comprehensive plan will put the executive branch back in the business of actively identifying, indicting, and convicting financial fraudsters, thereby restoring culpability while protecting the public. Bank Whistleblowers United is asking that the presidential candidates vow not to take campaign contributions from any financial firm that has been charged with committing “legal elements of fraud” and limiting the individual contributions made by officers of such firms to no more than $250. Other proposals include: (i) restoring the position of criminal referral coordinators at every federal agency  to meet with their counterparts in law enforcement to push for prosecutions and continually improve the process and make it more transparent, (ii) require federal agencies to create a “Top 100” list of exclusive fraud schemes in their jurisdiction, in an effort to end the emphasis on deferred prosecution agreements that let corporations and individuals get away with paying a fine or agreeing to independent monitoring instead of facing a criminal conviction.

Bank Whistleblowers United believes that implementing their proposed changes could lead to indictments. For example, they are calling for the public release of reports from Clayton Holdings, a third-party “due diligence” firm. Bank Whistleblowers United Claims that the reports from January 2006 to June 2007 tested mortgage loans during the peak of the housing bubble and informed banks that nearly one in three of the loans sampled failed to meet the standards. Bank Whistleblowers United says that notwithstanding these findings, many prospectuses provided by the banks to investors misrepresented the quality of the loans contained in the pools and they cite to a January 2011 report by Financial Crisis Inquiry Commission (“FCIC”) Chair Phil Angelides which found that this conduct raised “the question of whether the disclosures were materially misleading, in violation of the securities laws.”

Banking Agency Developments


Federal Banking Agencies Expand Number of Banks and Savings Associations Qualifying for 18-Month Examination Cycle

On February 19th, the Office of the Comptroller of the Currency (“OCC”), in conjunction with the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Reserve Board of Governors, announced that they have increased the number of small banks and savings associations eligible for an 18-month examination cycle rather than a 12-month cycle. The changes are intended to reduce regulatory compliance costs for smaller institutions while maintaining safety and soundness protections. Comments will be accepted for 60 days from publication in the Federal Register. OCC Press Release.

OCC Hosts Risk Governance and Compliance Workshops in Atlanta

On February 18th, the OCC announced that it will host two workshops in Atlanta, March 15-16, for directors of national community banks and federal savings associations supervised by the OCC. The Risk Governance workshop on March 15th will provide practical information for directors to effectively measure and manage risks and will focus on the OCC’s approach to risk-based supervision and major risks in the financial industry. The Compliance Risk workshop on March 16th will discuss critical elements of an effective compliance risk management program and will focus on major compliance risks and critical regulations. OCC Press Release.


FDIC Board Approves Proposal on Deposit Account Recordkeeping Requirements to Facilitate Timely Access to Deposits in Large Bank Failures

On February 17th, the FDIC approved a proposal for recordkeeping requirements for FDIC-insured institutions with a large number of deposit accounts to facilitate rapid payment of insured deposits to customers if the institutions were to fail. The proposed rule would apply to insured depository institutions with more than two million deposit accounts. Under the proposal, these institutions would generally be required to maintain complete and accurate data on each depositor. In addition, the institutions would be required to ensure that their information technology systems are capable of calculating the amount of insured money for each depositor within 24 hours of a failure. The FDIC is not proposing or considering making these requirements applicable to smaller institutions, including community banks. The FDIC will accept comments on the proposal for 90 days after it is published in the Federal Register. FDIC Press Release.

Treasury Department Developments


CFPB Finalizes Policy to Facilitate Consumer-Friendly Innovation

On February 18th, the Consumer Financial Protection Bureau (“CFPB”) finalized a policy to facilitate consumer access to financial products and services that promise substantial benefit to consumers. The new policy establishes a process for companies to apply for a statement from CFPB staff that would reduce regulatory uncertainty for a new product or service that offers the potential for significant consumer-friendly innovation. The policy was proposed in October 2014. CFPB Press Release.

Securities and Exchange Commission

Proposed Rules and Requests for Comments

SEC Grants Additional Time for Comments on Transfer Agent Regulation Proposal

The SEC announced on February 18th that it has extended the comment period for its Advance Notice of Proposed Rulemaking, Concept Release and Request for Comment relating to transfer agent regulations. Comments should now be submitted on or before April 14, 2016. SEC Release No. 34-77172.

SEC and FDIC Propose Rule Implementing Dodd-Frank Provisions Regarding Liquidation of Covered Broker-Dealers

The SEC and the FDIC jointly issued a proposed rule on February 17th that would implement provisions relating to the orderly liquidation of covered brokers and dealers under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rule seeks to clarify how the customer protections of the Securities Investor Protection Act will be integrated with the other provision of Title II; the roles of the FDIC as receiver and the Securities Investor Protection Corporation (“SIPC”) as trustee for a covered broker-dealer; and the administration of claims in the orderly liquidation of a covered broker-dealer. Comments should be submitted within 60 days of publication in the Federal Register. SEC Release No. 34-77157.


Investment Management Offers Guidance on Mutual Fund Valuation Guidance

The SEC’s Division of Investment Management published responses to frequently asked questions regarding the valuation guidance for all mutual funds provided in the July 2014 money market fund reforms adopting release. The guidance, which was released by the SEC on February 11th, addresses a mutual fund’s board of directors’ responsibilities relating to the use of evaluated prices and the calculation of shadow prices by mutual funds using the amortized cost method. Valuation Guidance Frequently Asked Questions.

No-Action Letters and Exemptive Relief

SEC Grants Exemption to FINRA and BATS from Some Tick Size Pilot Program Data Collection Requirements

On February 17th, the SEC’s Division of Trading and Markets granted the Financial Industry Regulatory Authority’s (“FINRA”) request for an exemption from certain data collection requirements in the Plan to Implement the Tick Size Pilot Program under Rule 608(c) of Regulation NMS. Among other things, FINRA will be exempt from the requirement to enforce compliance with certain retail investor order identification requirements, to report certain order information in microsecond increments, and to report certain information “at the time of order execution.” On February 10th, the Division of Trading and Markets granted a similar exemption to BATS Exchange, Inc.

Other Developments

Advisory Committee on Small and Emerging Companies Agenda Focuses on Capital Formation

The SEC announced the agenda for the February 25th meeting of the Advisory Committee on Small and Emerging Companies and invited the public to submit comments to the committee. The meeting will focus on capital formation for small and emerging companies, including data on capital raised in unregistered securities offerings. SEC Press Release.

Staff Announcements

Daniel Kahl will serve as the Chief Counsel of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), according to an announcement on February 17th. SEC Press Release.

SEC Educates Investors on Securities-Based Crowdfunding

The SEC’s Office of Investor Education and Advocacy published an Investor Bulletin on February 16th that provides guidance to investors regarding investing in securities-based crowdfunding. SEC Investor Bulletin.

SEC Investor Advocate Discourages Nasdaq from Weakening Shareholder Approval Rules

SEC Investor Advocate Rick Fleming issued a letter on February 12th in response to a request by The NASDAQ Stock Market LLC (“Nasdaq”) for comments regarding potential changes to Nasdaq’s shareholder approval rules. In the letter, Fleming emphasized the importance of shareholder approval in the corporate governance framework, discouraged any attempt by Nasdaq to reduce or eliminate shareholder approval requirements, and questioned whether board or independent committee approval could serve as an adequate substitute for shareholder approval. SEC Investor Advocate Letter.

Commodity Futures Trading Commission

CFTC Staff Extends Request for Comment Period on Draft Technical Specifications for Certain Swap Data Elements

On February 18th, the U.S. Commodity Futures Trading Commission’s (“CFTC”) Division of Market Oversight (“DMO”) and Office of Data and Technology staff extended to March 7, 2016 the request for comment period on the draft technical specifications for certain prioritized swap data elements and associated questions. The extension will allow the CFTC’s Technology Advisory Committee and other interested parties to discuss the request for comment at a public meeting on February 23, 2016. The request for comment seeks public input on 80 enumerated questions addressing 120 data elements for several swap data reporting topics including counterparty-related elements, price, clearing, product, periodic reporting, orders, package transactions, options, additional fixed payments, notional amount, events, rates and foreign exchange. CFTC Press Release.

CFTC’s Division of Market Oversight Provides Time-Limited No-Action Relief for End Users from the Form TO Filing Requirement

On February 18th, the CFTC issued a no-action letter providing time-limited relief for end users from the Form TO filing requirement under CFTC regulations. Under CFTC Regulation 32.3(b)(2), counterparties to trade options that are not required to be reported to a swap data repository (“SDR”) must submit a Form TO filing by March 1st following the end of any calendar year during which they entered into one or more unreported trade options.CFTC Press Release.

CFTC Staff Provides No-Action Relief from Registration to Certain Intermediaries Located Outside of U.S.

On February 12th, the CFTC’s Division of Swap Dealer and Intermediary Oversight issued no-action relief from registration for persons located outside the U.S. who act as Introducing Brokers, Commodity Trading Advisors, or Commodity Pool Operators in connection with swaps that are not subject to a CFTC clearing requirement on behalf of persons located outside the U.S. This relief allows certain intermediaries to take advantage of the exemption from registration in CFTC Regulation 3.10(c)(3)(i), without meeting the condition that those intermediaries submit commodity interest transactions for clearing through registered Futures Commission Merchants in connection with swaps that are not required to be cleared. CFTC Press Release.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations


SEC Approves BATS’ Proposed Prohibition on Disruptive Quoting and Trading

On February 18th, the SEC approved a rule change proposed by BATS Exchange, Inc. (“BATS”) that would prohibit certain disruptive quoting and trading activities on the BATS exchange and would establish a new Expedited Client Suspension Proceeding conducted by BATS in cases where it believes the prohibition on disruptive quoting and trading activities has been violated. SEC Release No. 34-77171.

Direct Edge

Direct Edge Exchanges Propose to Adopt New Early Trading Session

On February 16th, the SEC provided notice of EDGA Exchange, Inc.’s (“EDGA”) and EDGX Exchange, Inc.’s(“EDGX”) separately filed proposals to amend their respective rules to create a new Early Trading Session and adopt three new time-in-force instructions. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of February 22, 2016.

Financial Industry Regulatory Authority

FINRA Letter Reflects Method for Assessing Firm Culture

FINRA published a targeted exam letter on February 18th that illustrates its approach to assessing firms’ practices in establishing and implementing firm cultural values. The letter asks firms to provide information regarding the key policies and processes by which they establish cultural values, the method in which these values are communicated to firm employees, and the processes firms use to identify and address policy breaches, among other things. FINRA Targeted Exam Letter.

FINRA Proposal Would Require Registration for Persons Responsible for Algorithmic Trading Strategies

On February 18th, the SEC requested comments on a proposed rule change filed by FINRA that would require associated persons primarily responsible for the design, development or significant modification of algorithmic trading strategies, or the day-to-day supervision of such activities, to register as Securities Traders. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of February 22, 2016. SEC Release No. 34-77175.

Municipal Securities Rulemaking Board

MSRB Prepares Advisors for New Pay-to-Play Regulations

The Municipal Securities Rulemaking Board (“MSRB”) announced on February 17th that municipal advisors will be subject to pay-to-play regulations beginning on August 17, 2016. The new regulations will provide greater transparency regarding municipal advisors’ political contributions and prohibit advisors from engaging in municipal advisory business with municipal entities for two years following political contributions to certain officials of those entities. The MSRB will host an educational webinar on the rule on July 7, 2016. MSRB Press Release.


Nasdaq’s Plan to Extend Compliance Period for Listed Companies to Hold Annual Shareholders Meeting

On February 12th, the SEC approved Nasdaq’s proposed rule change that would permit Nasdaq’s Listing Qualifications Department to use limited discretion to allow a listed company that fails to hold its annual shareholders meeting in a timely fashion additional time to comply with the annual meeting requirement. SEC Release No. 34-77137.


NYSE Arca Withdraws Proposal Regarding Treatment of Trade Reports for Exchange Traded Products

On February 18th, the SEC announced that NYSE Arca, Inc. (“NYSE Arca”) has withdrawn a proposed rule change to adopt a new policy relating to its treatment of trade reports for Exchange Traded Products that it determines to be inconsistent with the prevailing market. SEC Release No. 34-77170.

Judicial Developments

Board’s Alleged “Entrenchment Transactions” Were a Valid Exercise of Business Judgment

Shareholders of an Indiana company, which owns two restaurant chains, brought a shareholder derivative suit against the company’s directors. Plaintiffs claimed that the board approved three “entrenchment transactions” that were intended to cement the CEO’s control of the company and enrich him at the expense of the other shareholders. The district court dismissed the suit, finding that plaintiffs failed to demonstrate demand futility as defined in Indiana law. The Seventh Circuit affirmed on February 17th, finding that the transactions were the product of a valid exercise of business judgment by the board. Biglari.

Investor’s Claims Against Hedge Fund Managers Are Derivative, Not Direct

A Florida investor brought a putative class action against hedge fund managers over an alleged $430 million loss on bad investments in a Chinese forestry company. The investor, who alleged breach of fiduciary duty, gross negligence and unjust enrichment, contended that his claims are “direct” under Delaware law. The district court dismissed the action, finding that the investor lacked standing to sue because he was not a direct investor. The Eleventh Circuit affirmed dismissal on February 17th, determining that the claims were derivative, not direct, as the investor was never a partner of the investment fund. Paulson.

Industry News

Head of Barclays Investment Bank to Retire

On February 19th, DealBook reported that Thomas King, the American in charge of the investment banking business at Barclays, is set to retire from the lender next month. This departure is the most prominent exit in a shake-up of management at the bank under its new chief executive, James E. Staley. DealBook.

Federal Reserve Is Relaxing Rules on Bank Capital

On February 18th, DealBook reported that the Federal Reserve is allowing a large diversified financial services holding company to buy back $300 million more in stock than was originally permitted under the most recent Dodd-Frank Act stress tests in 2015. DealBook.

Survey Finds That CFOs Are Losing Confidence That Their Reports Comply with All Reporting Needs

On February 18th, publication CFO reported on a new Ernst & Young survey that found that chief financial officers are losing confidence in the effectiveness of corporate reporting. The survey of 1,000 chief financial officers across 25 countries in organizations with revenue greater than $500 million found confidence across all key aspects of corporate reporting has fallen as compared with 2014. The biggest decline was in “confidence in degree of compliance,” with only 55% of respondents saying they are fully or somewhat confident, compared with 84% in 2014. Ernst & Young identified several reasons for the loss of confidence in reporting, including the increased complexity of reporting, growing demand, and pressure on resources. The survey also found that chief financial officers are feeling the ripple effect of increased scrutiny being placed on audit committees and supervisory boards. Eighty-four percent of respondents say that audit committees and boards have increased their overall attention on reporting in the past three years, with 34% saying that the attention has increased significantly. CFO.