US Regulatory Update
Fair Access to Investment Research Act of 2017
On 27 September, the House of Representatives passed S. 327, the Fair Access to Investment Research Act of 2017. The bill would require the SEC to: (i) provide a safe harbor for certain investment fund research reports that are published or distributed by a broker-dealer; and (ii) exempt broker-dealers distributing research concerning SEC-registered investment companies from certain applicable rules. In implementing the safe harbor, the SEC must “prohibit a self-regulatory organization from maintaining or enforcing a rule that would prevent a member from: (1) publishing or distributing a covered investment fund research report solely because the member is also participating in a registered offering of the fund, or (2) participating in a registered offering of a covered investment fund solely because the member has published a research report about the fund.” The bill will now be sent to the President to be signed into law.
Sen. Gillibrand and Sen. Durbin Announce Stop CEO Excessive Pay Act
On 20 September, Sen. Kirsten Gillibrand (D-NY) and Sen. Dick Durbin (D-IL) announced the Stop CEO Excessive Pay Act, legislation aimed at addressing executive compensation. The bill would: (i) eliminate company tax deductions on executive compensation that are “excessive,” in an effort to close the executive compensation loophole; (ii) require approval from a majority of shareholders in order to award “excessive” amounts of executive compensation; and (iii) authorize the SEC to impose a non-tax-deductible fine for the amount of executive compensation paid, in the event that a company does not receive the required majority vote within the an 18-month window following the issuance of “excessive” executive compensation. “Excessive” executive compensation is defined in the legislation as “more than 25 times the median income of their employees or more than $1 million, whichever is less.”
SIFI & FINANCIAL STABILITY
FSOC Meeting and Designation
On 29 September, the FSOC held an executive session to discuss an update on the annual re-evaluation of the designation of AIG as a systemically important financial institution (“SIFI”) and consideration of the Council’s 2018 budget. Based on discussions at the executive session, the Council announced that it voted, 6-3, in favor of “rescind[ing] its determination that material financial distress at American International Group, Inc. (AIG) could pose a threat to U.S. financial stability” and de-designated AIG as a nonbank SIFI. Treasury Secretary Steven Mnuchin announced that “[t]his action demonstrates our commitment to act decisively to remove any designation if a company does not pose a threat to financial stability.” In addition, the Council approved its fiscal year 2018 budget.
FSOC Meeting and Designation
On 22 September, the FSOC met in an executive session to discuss an update on the annual
re-evaluation of the designation of a nonbank financial company and consideration of the Council’s 2018
budget. The FSOC also approved the minutes of the previous meeting on July 28, 2017, which addressed: (i) “recommendations regarding the Volcker Rule in Treasury’s June 2017 report prepared pursuant to the presidential executive order on core principles for regulating the U.S. financial system, issued February 3, 2017”; (ii) an “update on Annual Reevaluation of Nonbank Financial Company Designation”; and (iii) the “pending litigation brought by MetLife against the Council relating to the Council’s final determination.”
Financial Stability Oversight Council Insurance Member Continuity Act
On 27 September, President Donald Trump signed into law H.R. 3110, the Financial Stability Oversight Council Insurance Member Continuity Act. The bill proposes to amend the Dodd-Frank Act in order to allow the FSOC’s independent member with insurance expertise to continue serving for up to 18 months past 30 September 2017, when the term for the current independent member, S. Roy Woodall, Jr., is set to expire, or until the confirmation of a replacement, whichever occurs first.
U.S. Department of Treasury and Office of the U.S. Trade Representative Sign Covered Agreement
On 22 September, the U.S. Department of Treasury and Office of the U.S. Trade Representative signed a covered agreement on prudential insurance and reinsurance between the U.S. and EU. The agreement will address three areas of prudential insurance oversight: (i) reinsurance; (ii) group supervision; and (iii) the exchange of insurance information between regulators. In a joint statement, the parties stated that “the Agreement provides meaningful benefits for U.S. and EU insurance consumers and for U.S. and EU insurers and reinsurers that operate in both markets” and that the parties “look forward to successful implementation of the Agreement, including through the Joint Committee established by the Agreement.”
Rep. Duffy and Rep. Heck Introduce Federal Insurance Office Reform Act of 2017
On 28 September, Rep. Sean Duffy (R-WI), Chairman of the Subcommittee on Housing and Insurance of the House Financial Services Committee, and Rep. Denny Heck (D-WA) introduced H.R. 3861, the Federal Insurance Office Reform Act of 2017, to reform the Federal Insurance Office (“FIO”). According to the press release, the bill would: (i) “move FIO to the Office of International Affairs within the Treasury Department”; (ii) “limit FIO’s role largely to international matters and provide that FIO speaks for Treasury (but not other federal agencies) in international discussions”; (iii) “authorize FIO to coordinate federal insurance policy and require FIO to achieve consensus with the states before advocating or agreeing to positions in international forums such as the [International Association of Insurance Supervisors]”; (iv) “eliminate FIO’s authority relating to purely domestic issues, including the authority to engage in broad information gathering authority and reporting obligations and issue subpoenas”; (v) “retain FIO’s existing authority to ‘Monitor all aspects of the insurance industry’ and advise the Treasury Secretary on the administration of the Terrorism Risk Insurance Act”; (vi) “continue the authority of Treasury and the United States Trade Representative to negotiate and enter into covered agreements (but the Secretary, not the FIO Director, would have the authority to determine whether a covered agreement preempts state law)”; (vii) “provide that a covered agreement may not include new prudential requirements for U.S. insurers”; and (viii) “limit the number of FIO employees to five.”
Rep. Duffy and Rep. Heck Introduce International Insurance Standards Act of 2017
On 13 September, Rep. Sean Duffy (R-WI), Chairman of the Subcommittee on Housing and Insurance of the House Financial Services Committee, and Rep. Denny Heck (D-WA) introduced H.R. 3762, the International Insurance Standards Act of 2017. The bill would: (i) “ensure that any international agreements on insurance regulation reflect the successful U.S. regime” or, in the event that changes are to be made, the bill proposes that changes are enacted in the U.S. before they are ratified in international forums; (ii) ensure the involvement of state insurance regulators in international agreements as part of the U.S. negotiating team; and (iii) “provide Congress additional formal oversight of any new international standard proposed by representatives of the U.S. federal government.”
SEC & SECURITIES
SEC Chairman Clayton Decides Not to Pursue Third Party Investment Advisor Examinations
On 28 September, SEC Chairman Clayton attended an event held by the Center on Regulation and Markets at the Brookings Institution exploring the “opportunities and challenges facing securities markets ten years after the financial crisis.” As reported by InvestmentNews, Chairman Clayton indicated that he would not pursue the idea of allowing “consulting firms, other regulators, or other third-party agents” to conduct third party examinations of registered investment advisors.
SEC Chairman Clayton Issues Statement on Cybersecurity
On 20 September, SEC Chairman Jay Clayton issued a statement “highlighting the importance of cybersecurity to the agency and market participants, and detailing the agency’s approach to cybersecurity as an organization and as a regulatory body,” as explained by the accompanying press release. In his statement, Chairman Clayton explained that, in May 2017, he initiated an assessment of the SEC’s internal cybersecurity risk profile, and provided details of the SEC’s cybersecurity approach. He also reported that the SEC learned in August 2017 that an “incident previously detected in 2016 may have provided the basis for illicit gain through trading.” Specifically, he stated that “a software vulnerability in the test filing component of our EDGAR system . . . was exploited and resulted in access to nonpublic information.” In the statement, Chairman Clayton noted that the Commission “believe[s] the intrusion did not result in unauthorized access to personally identifiable information, jeopardize the operations of the Commission, or result in systemic risk.” He went on to stress that the “Commission will continue to prioritize its efforts to promote effective cybersecurity practices within the Commission itself and with respect to the markets and market participants it oversees.”
Senate Banking Committee Hearing on the Oversight of the SEC
On 26 September, the Senate Banking Committee held a hearing on the oversight of the SEC. SEC Chairman Jay Clayton testified on issues related to, among others: (i) the breach of the SEC’s Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) system; (ii) the Department of Labor’s (“DOL”) Fiduciary Duty Rule; (iii) the consolidated audit trail (“CAT”); (iv) Regulation Systems Compliance and Integrity (“Reg SCI”); (v) capital markets; (vi) regulatory reform; and (vii) the Equifax data breach.
- Cyber Breach of the SEC’s EDGAR System: SEC Chairman Clayton fielded multiple questions from Committee members regarding the details of the cyber breach and the actions he and the Commission took in response to the breach. Clayton generally stated that he did not have any additional details on the breach, and that he: (i) does not have any information regarding the type of defect that led to the breach other than that it was a due to a “custom piece of software”; (ii) could not provide the exact month that the breach occurred in; (iii) could not provide a timeline of the SEC’s review of the breach; and (iv) believes that former SEC Chair Mary Jo White had no knowledge about the breach when she was Chair of the SEC. With regards to his response, Clayton noted that the SEC has taken additional steps to address this issue, including: (i) “hiring outside consultants to do penetration testing”; and (ii) conducting “constant reviews of the EDGAR system” to prevent another breach from occurring. Clayton also indicated that the SEC requires additional resources to address cybersecurity issues. When questioned by Sen. Jack Reed (D-RI) about the SEC’s use of the $50 million reserve fund established by the Dodd-Frank Act for the SEC to use on technology initiatives, Clayton responded that the SEC is actively using the reserve funds to address cybersecurity and other technology initiatives and reiterated the need for additional resources.
- DOL Fiduciary Duty Rule: When questioned by Sen. Tim Scott (R-SC) about coordination between the SEC and the DOL on the Fiduciary Duty Rule, Clayton stated that the two agencies should work together to address the issue. Clayton indicated that the SEC is currently reviewing feedback following a “request for updated views from investors and industry participants on the effects of the DOL Rule and what [should be done] going forward in terms of the standard of conduct.” Clayton upheld that any joint rulemaking needs to ensure that there is “choice” for investors, “clarity” such that investors know “the type of person they are dealing with,” “consistency” between retirement and non-retirement accounts, and “coordination” between the SEC, DOL and state regulators. When questioned by Sen. Jon Tester (D-MT) on whether the SEC is currently working with the DOL on a harmonized rule, Clayton indicated that this is an issue at the “top of [his] list in that area of the Commission.”
- CAT: Committee Chairman Mike Crapo (R-ID) questioned Chairman Clayton on whether it is necessary to gather the type of data to be collected by the CAT, such as “personal identifiable information,” and whether such data can be adequately protected. Clayton responded stating that the data to be collected by CAT is “very valuable to [the SEC’s] oversight role,” especially with regards to “insider trading and monitoring of investment managers and broker-dealers,” but that the Commission would not “take sensitive data that does not further [the SEC’s] mission.” When questioned by Sen. Mike Rounds (R-SD) on whether there needs to be a “time out” on the implementation of the CAT to allow additional reviews of the system before it becomes operational, Clayton indicated that he did not believe a “full time out made sense,” but will review the types of data to be collected and whether they are able to securely store such data.
- Reg SCI: When questioned by Sen. Mark Warner (D-VA) about whether Clayton will review and expand Reg SCI to parts of the market that are not currently covered, such as “dark pools, alternative trading systems, treasury markets, and other trading platforms,” Clayton indicated that it was important for the SEC to review whether those venues should be “reporting on the same basis” and to ensure that the public has enough information about such venues.
- Capital Markets: Sen. Elizabeth Warren (D-MA) criticized Clayton’s analysis of IPO trends, noting that the data show that “investors are putting more money into IPOs now than ever before and that those IPO companies are doing better for investors because they are more stable before they come to market.” She continued that “there is no evidence that [loosening the disclosure and registration requirements] will make life better for investors.” When questioned by Sen. Richard Shelby (R-AL) on recent IPO trends, Clayton argued that a large capital market will provide retail investors with more access to investment choices.
- Regulatory Reform: When questioned by Sen. Shelby on what the SEC is doing or could do to establish a “meaningful cost-benefit analysis rule,” Clayton indicated that cost-benefit analyses are important in rulemaking to determine whether a rule should be promulgated and whether rules provide the most efficient way of achieving the “best compliance.” Clayton said that he was working with the Commission’s economists to determine the impact of their rules.
- Equifax Data Breach: When questioned by Ranking Member Sherrod Brown (D-OH) on whether “materiality” is the right disclosure standard for cyber breaches, Clayton responded that “materiality is the core of our disclosure system” but questioned whether companies are making the “right materiality assessments.” Clayton stated that “companies should be disclosing more,” providing disclosures about intrusions sooner, and providing “better disclosure about their risk profile.” When further questioned by Ranking Member Brown about whether there is a concern that executives have been unjustly enriched amid data breaches, Clayton indicated that the he intends to “finish the mandate” of the “claw back rule” to address incidents such as these.
SEC Adopts Interpretive Guidance on Pay Ratio Rule
On 21 September, the SEC published interpretive guidance “to assist registrants in preparation of their pay ratio disclosures required by Item 402(u) of Regulation S-K.” Under Regulation S-K, registrants must “provide pay ratio disclosure for the first fiscal year beginning on or after January 1, 2017, which means that registrants will begin making pay ratio disclosures in early 2018.” The interpretive guidance provides clarity on the following: (i) “the Commission’s views on the use of reasonable estimates, assumptions and methodologies, and statistical sampling permitted by the rule”; (ii) “a company may use appropriate existing internal records, such as tax or payroll records, in determinations about the inclusion of non-U.S. employees and in identifying the median employee”; and (iii) “when a company may use widely recognized tests to determine whether its workers are employees for purposes of the rule.” In addition, the SEC’s Division of Corporate Finance published staff guidance on the calculation of the pay ratio disclosure, which “includes examples illustrating how reasonable estimates and statistical methodologies may be used, [and] is intended to assist companies with their compliance efforts and reduce the costs associated with preparing disclosures.”
SEC Adopts New Initiatives to address Cybersecurity and Protect Retails Investors
On 25 September, the SEC announced two new initiatives including: (i) a “Cyber Unit” focusing on addressing cyber-related misconduct; and (ii) a “Retail Strategy Task Force” that will implement initiatives that affect retail investors. The SEC believes that these initiatives “will build on its Enforcement Division’s ongoing efforts to address cyber-based threats and protect retail investors.”
- Cyber Unit: According to the press release, the Cyber Unit will address cyber-related misconduct, such as: (i) “market manipulation schemes involving false information spread through electronic and social media”; (ii) “hacking to obtain material nonpublic information”; (iii) “violations involving distributed ledger technology and initial coin offerings”; (iv) “misconduct perpetrated using the dark web”; (v) “intrusions into retail brokerage accounts”; and (vi) “cyber-related threats to trading platforms and other critical market infrastructure.” Robert A. Cohen, currently the Co-Chief of the SEC’s Market Abuse Unit, has been appointed Chief of the Cyber Unit.
- Retail Strategy Task Force: According to the press release, the task force will “develop proactive, targeted initiatives to identify misconduct impacting retail investors” and include “enforcement personnel from around the country [that] will work with staff across the SEC, including from the SEC’s National Exam Program and the Office of Investor Education and Advocacy.”
CFTC & Derivatives
CFTC’s Office of Inspector General Publishes White Paper on Lean Labor and the CFTC
On 27 September, the CFTC’s Office of the Inspector General published a white paper exploring “whether Lean Labor principles would be useful for the [CFTC].” The white paper attempted to identify possible redundancies in the Division of Market Oversight (“DMO”) and the Division of Clearing and Risk (“DCR”) by examining the “effectiveness of the current balance of labor and workforce.” The report concluded that: (i) while the DMO “currently does not follow Lean,” certain DMO practices do support Lean Labor principles; and (ii) “by further implementing Lean . . . the CFTC may increase productive time and/or reduce costs.” The white paper also suggested that the CFTC “[r]eevaluate and restructure unit workforce staffing through attrition and/or retirement options to lower costs.” In response to the white paper, CFTC Executive Director Anthony Thompson sent a memorandum (attached to the white paper) to CFTC Inspector General A. Roy Lavik stating that the “CFTC will consider using the lean labor evaluation methodology where it fits into the Commission's commitment to establishing a performance and process improvement effort,” but that “the tools necessary to support the work of knowledge workers may be different from what is envisioned in a Lean culture.”
CFTC’s Division of Enforcement Updates Self-Reporting and Cooperation Program
On 25 September, the CFTC’s Division of Enforcement issued an Enforcement Advisory updating the Division’s self-reporting and cooperation program (first announced on 19 January 2017) and two previous Enforcement Advisories, available here and here (issued on 19 January 2017). The latest Enforcement Advisory provides “additional information regarding voluntary disclosures and the substantial credit companies and individuals can expect from the Division if they voluntarily disclose misconduct and fully cooperate with the Division’s investigation.” Specifically, for reporters to receive the benefits from the program, they must ensure that: (i) “voluntary disclosure [is] made prior to an imminent threat of exposure of the misconduct”; (ii) “the disclosure [is] made to the Division within a reasonably prompt time after the company or individual becomes aware of the misconduct; (iii) “the disclosure include[s] all relevant facts known to the company or individual at the time of the disclosure, including all relevant facts about the individuals involved in the misconduct”; (iv) reporters “adhere to the terms of the Division’s January 2017 Advisories”; and (v) that there is “timely and appropriate remediation of flaws in compliance and control programs.” If the reporter satisfies these requirements, the Division will recommend “the most substantial reduction” in applicable civil monetary penalties and, in “extraordinary circumstances,” decline to prosecute. The Division provided that aforementioned “extraordinary circumstances” may include examples whereby “misconduct is pervasive across an industry and the company or individual is the first to self-report.”
On 25 September, the CFTC’s Division of Enforcement Director James McDonald delivered a speech regarding the Division of Enforcement’s “cooperation and self-reporting program.” In addition to outlining the details of the Enforcement Advisory, he stated that, for reporters who satisfy the self-reporting requirements, the Division will: (i) “clearly communicate with the company—at the outset—[the Division’s] expectations regarding self-reporting, cooperation, and remediation”; and (ii) “work with [the company] on remediation . . . whatever the facts and circumstances.”
Commissioner Bowen Farewell Address
On 25 September, CFTC Commissioner Sharon Y. Bowen delivered her farewell address. Among other things, she discussed her beliefs regarding: (i) the importance of the expansion of central clearing for standardized derivatives; (ii) the CFTC’s efforts to advance international cooperation; (iii) advancements that have been made regarding data harmonization; (iv) achievements of the Market Risk Advisory Committee; (v) the need to focus on cybersecurity related issues; and (vi) her concerns over issues related to high-frequency trading.
Brian A. Bussey Appointed as Director of the Division of Clearing and Risk
On 28 September, the CFTC announced the appointment of Brian A. Bussey, Associate Director for Derivatives Policy and Trading Practices in the SEC’s Division of Trading and Markets, as the Director of the Division of Clearing and Risk.
Matthew Kulkin Appointed as Director of the Division of Swap Dealer and Intermediary Oversight
On 20 September, the CFTC announced the appointment of Matthew B. Kulkin, a partner from Steptoe & Johnson LLP, as the Director of the CFTC’s Division of Swap Dealer and Intermediary Oversight.
Commissioner Quintenz Named Sponsor of Technology Advisory Committee
On 18 September, the CFTC announced that Commissioner Brian Quintenz will sponsor the CFTC’s Technology Advisory Committee, which “advises the CFTC on technological innovations in the markets and the appropriate regulatory response to those advances.”
DOL FIDUCIARY DUTY RULE
SEC Chairman Speaks on DOL Fiduciary Duty Rule
On 28 September, SEC Chairman Jay Clayton spoke at the Brookings Institution and he stated that “some of the motivations for the [DOL Fiduciary Duty Rule] are real,” such as instances in which investment advisers did not disclose conflicts. He said that the SEC and DOL’s cooperation on a fiduciary rule should give investors a standard with “choice, consistency, clarity, and cooperation.”
Rep. Wagner Introduces Bill to Repeal DOL’s Fiduciary Duty Rule
On 27 September, Rep. Ann Wagner (R-MO) introduced the Protecting Advice for Small Savers (PASS) Act of 2017, a legislative proposal to eliminate and replace the DOL’s Fiduciary Duty Rule with a “best interest” standard under the jurisdiction of the SEC. Among other things, the bill would: (i) require brokers-dealers to provide recommendations in the “retail customer’s best interests” by “reflecting reasonable diligence” and “reasonable care, skill and prudence”; (ii) require broker-dealers to “disclose prior to the point of sale . . . the types of compensation . . . the broker or dealer receives” and “any material conflict of interest,” among other things; (iii) authorize the SEC to issue “regulations determining the content of [such] disclosures” and require broker-dealers to “avoid, disclose, or otherwise reasonably manage any material conflict of interest”; (iv) state that a broker-dealer is not required to “recommend the least expensive security or investment strategy,” and would generally enable broker-dealers to (1) receive transaction-based compensation, (2) engage in principal transactions, (3) recommend “proprietary products” or “a limited range of products or services,” and (4) provide an exemption for “the manufacture or sale of annuities” subject to certain conditions; (v) restrict the SEC’s rulemaking authority such that the SEC cannot “impose any obligation related to standard of care on a broker or dealer that is in addition to, duplicative of, or inconsistent with, the obligations” established by certain sections of the bill; (vi) mandate that the “Secretary of Labor and the Secretary of the Treasury shall not promulgate any regulation under the Employee Retirement Income Security Act” regarding the fiduciary duty of broker-dealers; and (vii) “supersede and preempt State law, other than a State law that regulates insurance products that are not securities.”
UPCOMING EVENTS AND DEADLINES
- 4 October: U.S. House Committee on Financial Services hearing on examining the SEC’s agenda, operations, and budget.
- 11 October: U.S. House Committee on Agriculture hearing examining the 2017 Agenda for the Commodity Futures Trading Commission (rescheduled from 27 September 2017).
- 12 October: SEC Investor Advisory Committee meeting to discuss (i) Blockchain and Other Distributed Ledger Technology and Implications for Securities Markets; (ii) an Overview of Law School Clinic Advocacy Efforts on Behalf of Retail Investors; and (iii) Electronic Delivery of Information to Retail Investors (which may include a Recommendation of the Investor as Purchaser Subcommittee).
- 23 October: CFTC Office of International Affairs 25th Annual Symposium.