US Regulatory Update
Treasury Department Releases Report Pursuant to President Trump’s April Memorandum on the Financial Stability Oversight Council
On 17 November, the U.S. Department of Treasury published its report in response to President Trump’s April memorandum directing Treasury Secretary Steven Mnuchin to “conduct a thorough review of the FSOC determination and designation process” for nonbank financial institutions and financial market utilities. Treasury’s report focused on broad issues, including “the effects and efficacy of [FSOC’s] process,” “the rigor of . . . analyses” that accompany designation decisions, and FSOC’s “engagement and transparency with firms, regulators, and the public.” The report included recommendations related to FSOC’s designation process for nonbank financial companies aimed at addressing these issues, including: (i) “prioritizing an activities-based or industry-wide approach to potential risks” to U.S. financial stability when making designation decisions; (ii) “increasing the analytic rigor of determination analyses” by introducing cost-benefit analysis to the process; (iii) “enhancing engagement and transparency in the designation process”; and (iv) “providing a clear ‘off-ramp’ for designated nonbank financial companies.” Treasury’s recommendations for the designation process of FMUs include: (i) maintaining FSOC’s “analytic framework for [FMU] designation”; (ii) continuing coordination between FSOC and the Federal Reserve, the CFTC, and the SEC regarding “the supervision of designated FMUs and . . . working collaboratively to develop effective resolution strategies focused on ensuring the continuity of the critical services provided by [FMUs]”; (iii) “consider[ing] incorporating cost-benefit analyses into [FSOC’s] evaluations of FMUs for potential designation”; and (iv) “enhancing engagement and transparency in the designation process.” Notably, Treasury’s report did not call for Congressional action to end FSOC’s designation powers, although legislation recently passed the House of Representatives that, if implemented, would do so. Instead, the report endorses legislative action to extend the length of time that nonbank firms have to challenge their designation.
House Passes Bill to Re-Authorize the National Flood Insurance Program
On 14 November, the House of Representatives passed, by a vote of 237-189, the 21st Century Flood Reform Act (H.R. 2874) – as modified by a 6 November amendment in the nature of a substitute offered by Rep. Sean Duffy (R-WI) – to re-authorize the national flood insurance program (“NFIP”) through fiscal year (“FY”) 2022. The substitute amendment adds provisions from six other bills passed by the House Committee on Financial Services, and is guided by an agreement between House Majority Whip Steve Scalise (R-LA) and House Financial Services Committee Chairman Jeb Hensarling (R-TX) “to scale back new flood-insurance restrictions for high-risk properties in legislation to renew the government’s program,” as Bloomberg reported earlier this month. Key provisions from the bill, as amended, include, among others: (i) Section 101, which would re-authorize the NFIP until 30 September 2022; (ii) Section 102, which would decrease from 18 to 15 percent the annual limitation on premium increases; (iii) Section 112, which would limit the premiums charged to any residential property to a maximum of $10,000, irrespective of the risk posed by the property; (iv) Section 201, which would mandate that the use of private flood insurance policies satisfy the NFIP’s mandatory coverage requirements; (v) Section 204, which would require the NFIP Administrator to publicly publish information relating to the NFIP that is used to assess flood risk or identify and establish flood elevations and premiums; (vi) Section 504, which would increase risk premium rates for properties for which multiple qualified claims payments have been made, until the rates matches the current flood risks to the property; and (vii) Section 505, which would prohibit the NFIP from providing insurance coverage to properties with an aggregate amount in claims that exceeds three times the replacement value of the property.
House Committee on Financial Services Passes 23 Bills
On 15 November, the House Committee on Financial Services passed 23 bills and posted vote totals and summaries of each of the 23 bills passed, including, among others:
- H.R. 4015, the Corporate Governance Reform and Transparency Act of 2017, passed by a vote of 40-20, which, according to the press release, would “provid[e] for, among other things, the registration of proxy advisory firms with the SEC, disclosure of proxy firms’ potential conflicts of interest and codes of ethics, and the disclosure of proxy firms’ methodologies for formulating proxy recommendations and analyses.”
- H.R. 4247, the Restoring Financial Market Freedom Act of 2017, passed by a vote of 33-25, which, according to the press release, would “repeal[l] Title VIII of the Dodd-Frank Act, which gives the Financial Stability Oversight Council (“FSOC”) the authority to designate certain payments and clearing organizations as [systemically important financial market utilities (“SIFMUs”)] [and] repea[l] all previous [SIFMU] designations announced by the FSOC from July 18, 2012.”
- H.R. 4279, Expanding Investment Opportunities Act, passed by a vote of 58-2, which, according to the press release, would “direc[t] the SEC to amend its rules to enable closed-end funds that meet certain requirements to be considered ‘well-known seasoned issuers’ (WKSIs) and to conform the filing and offering regulations for closed-end funds to those of traditional operating companies, thereby simplifying the registration process.”
Legislative Developments Related to the SEC
On 1 November, the House of Representatives passed, by a voice vote, the Fair Investment Opportunities for Professional Experts Act, H.R. 1585. As explained in the bill summary, it would amend the definition of accredited investor in the Securities Act of 1933 to include: (i) “an individual whose net worth, or joint net worth with their spouse, exceeds $1 million, excluding [the value of] their primary residence”; (ii) “an individual whose income over the last two years exceeded $200,000, or joint spousal income exceeded $300,000”; (iii) “an individual who holds a state-issued financial services license”; and (iv) an individual determined by the SEC to have qualifying education or experience to qualify as having professional subject-matter knowledge related to a particular investment.”
On 13 November, the House of Representatives passed, by a voice vote, the Market Data Protection Act of 2017, H.R. 3973. The bill would: (i) require the SEC, the Financial Industries Regulatory Authority (“FINRA”), and the operator of the Consolidated Audit Trail (“CAT”) to consult with the SEC’s Chief Economist to “develop comprehensive internal risk control mechanisms to safeguard and govern the storage of all market data by such entit[ies], all market data sharing agreements of such entit[ies], and all academic research performed at such entit[ies] using market data”; and (ii) prohibit the operator of the CAT from accepting market data until the operator develops such internal risk control mechanisms.
SIFIs & FINANCIAL STABILITY
Financial Stability Oversight Council Holds Open and Executive Session
On 16 November, Treasury Secretary Steven Mnuchin convened a meeting of the FSOC in open and executive sessions. According to the meeting readout, during the open session the participants: (i) “voted to approve revisions to its regulation implementing the Freedom of Information Act (FOIA) in accordance with the FOIA Improvement Act of 2016”; (ii) “received an update from the Federal Reserve on the work of the Alternative Reference Rates Committee”; and (iii) “heard a presentation from the Office of Financial Research on efforts to collect data to support alternative reference rates.” The Council also voted to approve the minutes of its previous meetings on 22 September 2017 and 29 September 2017, which cover, among other things, (i) FSOC’s rescission of its designation of American International Group, Inc. as a nonbank systemically important financial institution; (ii) the Council’s FY 2018 Council Budget; and (iii) the cybersecurity breach at Equifax Inc.
SEC & SECURITIES
SEC’s Division of Enforcement Issues Report on Priorities and Fiscal Year 2017 Results
On 15 November, the SEC’s Division of Enforcement issued an annual report highlighting the Division’s priorities for the coming year and reviewing the results of the Division’s activities for FY 2017. As part of the report, Stephanie Avakian and Steven Peikin, the Division of Enforcement’s co-directors, detailed five core principles that will guide the Division’s decision-making, including: (i) “focus[ing] on the main street investor,” including “accounting fraud, sales of unsuitable products and the pursuit of unsuitable trading strategies, pump and dump frauds, and Ponzi schemes”; (ii) “focus[ing] on individual accountability”; (iii) “keep[ing] pace with technological change,” and utilizing the recently formed Cyber Unit to “investigate and prosecute these increasing[ly] technologically-driven violations and coordinate with the Department of Justice and other criminal authorities”; (iv) imposing sanctions such as “obtaining monetary relief in the form of disgorgement, penalties, and asset freezes,” “barring wrongdoers from working in the securities industry,” and “when appropriate, obtaining more tailored relief, such as specific undertakings, admissions of wrongdoing, and monitoring or other compliance requirements”; and (v) “constantly assess[ing] the allocation of our resources.”
SEC Chairman Jay Clayton Denies Request by SROs to Extend CAT Reporting Deadline
On 14 November, SEC Chairman Jay Clayton issued a statement denying an exemptive request issued by national securities exchanges and FINRA (collectively, the “SROs”) to delay their reporting requirements under the consolidated audit trail (“CAT”) plan. Chairman Clayton noted that in light of the 15 November 2017 effective date for the first phase of CAT reporting under the CAT plan, the SROs submitted, on 13 November 2017, “an exemptive request to the Commission that makes clear that they will not meet that deadline and certain other deadlines contemplated by the plan” and requested that “the Commission issue broad exemptive relief extending the initial deadline by a year and other deadlines by a year or more.” In denying the request, Chairman Clayton stated that he is “not in a position to support the issuance of the requested relief on the terms currently proposed,” but indicated that he and the Commission will “engage with the SROs on these issues.” In addition, Chairman Clayton also stated that he has “made it clear that the SEC will not retrieve sensitive information from the CAT unless we believe appropriate protections are in place” and that SEC staff “is currently conducting an evaluation of [its] needs for personally identifiable information (‘PII’) in the CAT.”
Remarks at the Practising Law Institute’s 49th Annual Institute on Securities Regulation Conference
On 8 November, SEC Chairman Jay Clayton delivered remarks before the Practising Law Institute’s 49th Annual Institute on Securities Regulation conference addressing matters related to (i) the SEC’s short-term rulemaking agenda and the SEC’s five-year strategic plan; and (ii) the SEC’s priorities for its long-term rulemaking agenda.
- Short-Term Agenda and Five-Year Plan: Noting that “SEC’s near-term agenda has swelled over the years” and that “over the past 10 years, the Commission has completed, on average, only a third of the rules listed on the near-term agenda,” Chairman Clayton remarked that the next near-term agenda will be shorter than in the recent past. This change, he explained, is “rooted in a commitment to increase transparency and accountability . . . to Congress, investors, issuers, and other interested parties about what rules we intend to pursue and have a reasonable expectation of completing over the coming year.” He added that a “shorter near-term agenda does not mean . . . that the work of the SEC is slowing down.” Chairman Clayton noted that in early 2018, the SEC will be “required to lay out the agency’s vision for the next four years.” He expects the SEC to “appl[y] a similar streamlining approach to the Commission’s new strategic plan.”
- Long-Term Agenda: Long-term priorities identified by Chairman Clayton included: (i) examining the lack of participation by retail investors in shareholder voting; (ii) reviewing the shareholder proposal process to examine the “appropriate level of ownership that should be required to submit shareholder proposals, as well as whether our current resubmission thresholds are too low”; (iii) focusing the SEC’s inspection and enforcement programs fee and expenses disclosure issues; (iv) examining penny stocks and the “conspicuous lack of transparency with respect to their financial condition and other key business information”; (v) monitoring scenarios “when a retail investor purchases a restricted security”; (vi) working to “seek clarity for investors” on issues related to initial coin offerings, such as how tokens are listed on exchanges, listing standards, valuation of tokens, and “what protections are in place for market integrity and investor protection”; and (vii) facilitating improvements in investor education, such as the SEC’s ongoing effort to create a “website that will contain a searchable database of individuals who have been barred or suspended as a result of federal securities law violations.”
On 9 November, Bloomberg reported that the SEC’s Division of Corporate Finance Director William Hinman, speaking at the same conference, stated that the SEC may issue a “‘refresh’ of 2011 staff guidance on disclosing cyberattacks to help give companies a better understanding of the agency's thinking on the matter.” As further reported by Bloomberg, Director Hinman emphasized the importance of firms: (i) “re-examin[ing] their insider trading policies to . . . specifically take into account how they will deal with events that are occurring”; (ii) “look[ing] at their disclosure controls and escalation procedures when they experience cyber incidents”; and (iii) ensuring that cyber-incidents are “looked at properly by the right levels of management with an eye toward not just handling the attack, but also the implications of the attack on the business itself.”
Senate Committee on Banking, Housing, and Urban Affairs Unanimously Approves Nomination of Hester Peirce and Robert Jackson as SEC Commissioners
On 1 November, the Senate Committee on Banking, Housing, and Urban Affairs voted unanimously to approve the nomination of Hester Peirce for a Republican Commissioner seat on the SEC and Robert Jackson for a Democratic Commissioner seat on the SEC. The nominations will now go to the Senate floor for a final vote, which has yet to be scheduled.
CFTC & Derivatives
Commentary of Chairman J. Christopher Giancarlo Titled “An EU Plan to Invade U.S. Markets”
On 6 November, CFTC Chairman J. Christopher Giancarlo published an op-ed in the Wall Street Journal titled “An EU Plan to Invade U.S. Markets,” in which he rejected the “European regulation of American financial companies.” Chairman Giancarlo’s op-ed highlighted the European Commission’s proposals to “authoriz[e] regulation of financial entities outside the EU by the European Central Bank and the European Securities and Markets Authority” (“ESMA”), arguing that such “overlapping and uncoordinated regulation by the EU would be disruptive, expensive and detrimental to the U.S. trading markets and economy.” He warned that “[i]f the U.S. accepts European regulation of American financial companies, it would set a dangerous precedent—potentially opening the door to all manner of other interference.”
Remarks of Chairman J. Christopher Giancarlo on RegTech
On 15 November, CFTC Chairman J. Christopher Giancarlo delivered remarks before the Singapore FinTech Festival. In his remarks, Chairman Giancarlo discussed the recently-launched “LabCFTC,” and indicated that the CFTC plans “to issue a call for public feedback on a series of innovation prize competitions we intend to begin in 2018 under the Science Prize Competition Act.” He also discussed his views on how “RegTech” can be beneficial for regulators and the market, emphasizing (i) “the importance of exponentially increasing computing power”; (ii) “increasingly powerful computers [that] have access to troves of data, which can be generated through digital networks and systems, as well as from ‘smart’ physical objects”; (iii) analytics software with “the ability to make sense of this plethora of data and drive concrete suggestions, conclusions, or action items”; and (iv) “advances in machine learning – and a future state of Artificial Intelligence.” These four factors, according to Chairman Giancarlo, “can make regulatory compliance and oversight cheaper, easier, and more accurate.” Chairman Giancarlo also expressed his belief that cyber-security and data security will be some of the “primary risks we must solve for in a digital world.”
Remarks of Commissioner Rostin Behnam on the Dodd-Frank Act and Derivatives Reform
On 14 November, CFTC Commissioner Rostin Behnam delivered remarks before the Georgetown Center for Financial Markets and Policy. In his remarks, Commissioner Behnam discussed the Dodd-Frank Act’s derivatives markets provisions and other key issues.
- Derivatives: Commissioner Behnam expressed support for initiatives adopted by Congress in the Dodd-Frank Act, such as (i) “moving standardized contracts to exchanges or electronic trading platforms—‘where appropriate’”; (ii) “mandatory clearing for most bilateral contracts through central counterparties (‘CCPs’)”; (iii) “reporting executed trades to trade repositories”; and (iv) “instituting higher capital requirements for non-centrally cleared contracts.” He said the CFTC is now “at an inflection point, where strategic regulatory decisions are critically important to determine the future of market transparency, resiliency, and systemic risk” and warned that “the CFTC must not indulge strong economic tailwinds and daily records in our capital markets as a means to justify changes to important policies that have, in most circumstances, proven to be sound infrastructure.”
- Other Key Issues: Commissioner Behnam highlighted three “hugely important” key issues facing the CFTC on a daily basis: (i) the CFTC’s future approach for enforcement, particularly related to fraud and manipulation, elder abuse, advancements in technology, and self-reporting strategies to incentivize violation disclosures; (ii) international cooperation between regulators, with a focus on overcoming challenges posed by Brexit, the EU’s post-crisis reforms, and Asian market reforms; and (iii) issues related to FinTech and cybersecurity.
Remarks of CFTC Chairman J. Christopher Giancarlo on Swaps Trading
On 13 November, CFTC Chairman J. Christopher Giancarlo delivered remarks before the International Swap Dealers Association (“ISDA”) Regulators and Industry Forum, with regards to: (i) swap execution facility (“SEF”) trading; (ii) CCP supervision; and (iii) international coordination.
- SEF Trading: In his remarks, Chairman Giancarlo announced that the Commission is considering implementing a different framework for the regulation of SEFs. He criticized the CFTC’s current approach to regulating SEFs and swaps as “an attempt to re-engineer the entire market structure of swaps execution,” wherein the CFTC (i) sought to dictate SEFs’ business models, (ii) imposed on swaps markets “forms and practices taken from listed futures markets,” and, (iii) “contrary to provisions of Dodd-Frank that permit SEFs to operate by ‘any means of interstate commerce,’” designed rules that “constrain[ed] swaps trading to two methods of execution – request-for-quote or central limit order book.” He said that the Commission will now seek to: (i) “enhance the professional conduct of swaps execution through licensure, testing and adoption and abidance of approved codes of industry conduct”; (ii) “encourag[e] liquidity formation, price discovery and trade execution . . . to take place in self-contained, licensed SEF environments”; and (iii) “rais[e] the professional standards and regulatory transparency of those environments.”
- CCP Supervision: In his remarks, Chairman Giancarlo emphasized the importance of the clearing mandate and indicated that the CFTC will focus on “improving CCP stress testing to ensur[e] that swap markets operate upon a strong and durable foundation.” He indicated that as part of this initiative, the CFTC will: (i) “continue to develop and refine its program of multi-CCP stress testing” to create stress testing that is “systemic, recurrent and iterative”; (ii) “invit[e] input into stress test design and results from appropriate fellow prudential and market regulators,” particularly from the Federal Reserve, as well as from the SEC and the FDIC; and (iii) “seek such input at the initial specification stage of its stress test design and development” with the aim of subsequently sharing stress test results with fellow regulators to “garner feedback to be incorporated into future stress tests.”
- International Coordination: Chairman Giancarlo stated that he was “open to receiving substantive input into the scope of our stress tests from overseas regulators, particularly the Bank of England and [ESMA].” He also addressed his recent comments in his 6 November 2017 op-ed published in the Wall Street Journal (see above), stating that his “opposition to such direct and duplicative oversight of U.S. CCPs by ESMA does not mean [he] reject[s] ESMA’s interest in the prudent operation of U.S. CCPs” and that he believes it would be beneficial for the EU and U.S. “if EU authorities will work with [the CFTC] in a collaborative manner that is deferential to [their] jurisdiction over [their] domestic markets.”
Keynote Address of Commissioner Brian Quintenz on the Swap Dealer De Minimis Threshold
On 2 November, CFTC Commissioner Brian Quintenz delivered the keynote address at the Smart Financial Regulation Roundtable. His remarks focused on the swap dealer de minimis threshold. During his speech, Commissioner Quintenz criticized the current methodology and application of the de minimis threshold as “Exhibit A of the prior CFTC leaderships’ one-size-fits-all philosophy . . . [which] imposes broad costs and regulatory burdens on generic activity without regard for achieving stated policy goals and mitigating identified risks.” Specifically, he argued that “[n]otional value is an incredibly poor measure of activity and an almost meaningless measure of risk” for swap dealers and urged the Commission to adopt a “better, more thoughtful registration metric . . . which better aligns costs with risk and assesses that risk against the backdrop of the entire swaps regulatory framework.” Commissioner Quintenz remarked that such risk-based metrics could include: (i) “the amount of capital a firm holds against its swaps book”; (ii) “the economic exposure of a firm’s swaps book”; or (iii) “some measure of a firm’s uncleared swaps transactions.” He also noted that, should the CFTC insist on using “only an activity-based metric to impose both risk-based and activity-based costs,” the Commission should “explore three possible modifications” to the threshold methodology, namely: (i) “broadening the Insured Depository Institution exclusion to align it with current lending practices”; (ii) excluding cleared swaps; and (iii) “treating all hedging swaps consistently and excluding them from the threshold.”
OFR Publishes Working Paper Titled “How Safe are Central Counterparties in Derivatives Markets”
On 2 November, the Office of Financial Research (“OFR”) published a working paper (co-authored by Mark Paddrik and H. Peyton Young) titled “How Safe are Central Counterparties in Derivatives Markets.” The authors “proposed a general framework for assessing the ability of a CCP to withstand a severe credit shock . . . [that] differs from conventional stress testing of CCPs in several key respects.” The authors: (i) “consider the possible impact of one or more members failing, not just the two members with the largest net exposures to the CCP”; (ii) “consider the impact of the failing member(s) on all their counterparties, including other members of the CCP as well as non-members”; (iii) “propose a novel estimation methodology that [places] a lower bound on the amount of network contagion in the absence of detailed information about the liquid reserves of individual firms”; and (iv) “show how to estimate bounds on the probability that the CCP will fail relative to the probability that an individual member will fail.” The working paper concludes that, overall, “conventional stress testing approaches may underestimate the potential vulnerability of the main CCP for this market” and that the authors’ “results do not include several channels that could further increase the amount of contagion and the concomitant risk of CCP default.”
DOL Fiduciary Duty Rule
House Committee on Education Hearing on the Policies and Priorities of the DOL
On 15 November, the House Committee on Education and the Workforce held a hearing to examine the policies and priorities of the Department of Labor (“DOL”). Labor Secretary Acosta testified on issues related to, among other things, the DOL’s enforcement of its Fiduciary Duty Rule. Ranking Member Robert Scott (D-VA) noted that Secretary Acosta had “indicated that the best interest standard [of the Fiduciary Duty Rule] is now in effect” and questioned "what would happen when a retiree has [his or her] best interest violated.” Labor Secretary Acosta responded that as long as “companies are proceeding in good faith” to implement the best interest standard, the DOL would be in a “compliance assistance mode.” He warned, however, that if companies “are not proceeding in good faith” or if there are “willful violations” of the standard, the DOL has “enforcement authority.” When questioned by Ranking Member Scott, Secretary Acosta clarified that “the enforcement authority within [the Employee Retirement Income Security Act ("ERISA”)] is a federal enforcement authority” and does not provide individuals with any individual remedies.
DOL Files Rule to Delay of Applicability Date of Certain Aspects of the DOL’s Fiduciary Duty Rule
On 1 November, the DOL submitted to the Office of Management and Budget (“OMB”) for review a final rule that would delay the applicability date of certain aspects of the DOL’s Fiduciary Duty Rule. The DOL rule would extend the transition period and postpone from 1 January 2018 to 1 July 2019 the applicability date of the Best Interest Contract (“BIC”) Exemption, Class Exemption for Principal Transactions, and the Prohibited Transaction Exemption 84-24, which relates to certain transactions involving insurance agents and brokers, pension consultants, insurance companies, and investment company underwriters. As reported by ThinkAdvisor, in a 2 November federal court filing, Labor Secretary Alexander Acosta stated that it will likely “take three weeks from the time of review by [the Office of Management and Budget]” for the 18-month delay “to be published as final.”
Lawsuits Against the DOL
On 15 November, the U.S. Court of Appeals for the District of Columbia Circuit stayed the case by the National Association for Fixed Annuities against the DOL and directed the parties to file a joint status report after the decision by the Fifth Circuit in an appeal brought by the Chamber of Commerce, or within 90 days of the date of the order.
On 3 November, the U.S. District Court for the District of Minnesota granted a motion to stay the case and a motion for preliminary injunction filed by Thrivent Financial in its lawsuit against the DOL for its Fiduciary Duty Rule. In granting the motion for preliminary injunction against the implementation and enforcement of the BIC Exemption’s anti-arbitration condition, the Court held that: (i) “Thrivent has sufficiently demonstrated the threat of irreparable harm, both now and in the future”; (ii) “because DOL concedes that the anti-arbitration condition violates the [Federal Arbitration Act], the Court finds that Thrivent is likely to succeed on the merits”; and (iii) the “balance of harms and public interest also weigh in Thrivent’s favor” as the “DOL will suffer no harm, and the public interest will be served” if the preliminary injunction is granted. In granting the motion to stay the case, Judge Nelson held that, in light of the DOL’s “reassessment of the challenged provision of the BIC Exemption,” “[s]taying this matter will allow the administrative process to fully develop, possibly resolving this dispute, and thereby promoting judicial economy.”
- November 30: The SEC’s 36th Annual Small Business Forum