Orrick's Financial Industry Week in Review

by Orrick, Herrington & Sutcliffe LLP
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Financial Industry Developments

SEC Issues Money Market Fund Reform Rules

On July 23, the SEC adopted amendments to the rules that govern money market mutual funds.  The new rules require a floating net asset value (NAV) for institutional prime money market funds to fluctuate, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets.  This provides non-government money market fund boards with new tools— liquidity fees and redemption gates—to address the problem of investor runs.  With a floating NAV, institutional prime money market funds are required to value their portfolio securities using market-based factors and sell and redeem shares based on a floating NAVReleaseFinal Rule.   

SEC Proposes Removing Credit Rating References and Amending Issuer Diversification Requirement

On July 23, the SEC re-proposed amendments, initially proposed in March 2011, related to the removal of credit rating references in rule 2a-7 and Form N-MFP of the Investment Company Act.  The re-proposed amendments would implement provisions of Dodd-Frank. Comments must be submitted within 60 days of the proposal's publication in the Federal Register.  Proposed Rule.    

FDIC Gives Guidance to S-Corporation Banks Regarding Dividends under Basel III

On July 21, the FDIC clarified how it will evaluate requests by S-Corporation Banks to make dividend payments that would otherwise be prohibited under the Basel III capital conservation buffer.  New Basel III capital rules include a capital conservation buffer which prohibits or limits the dividends a bank can pay when its risk-based capital ratios fall below certain thresholds.  If an S-corporation bank has income but is limited from paying dividends as a result of the new rules, its shareholders may have to pay taxes on their pass-through share of the S-corporation's income from their own resources.  To avoid this problem, a bank may request approval from their primary federal regulator to make a dividend payment that would not otherwise be permitted.  Absent serious safety-and-soundness concerns about the requesting bank, the FDIC generally would expect to approve such requests by well-rated S-corporation banks that are limited to the payment of dividends to cover shareholders' taxes on their portion of an S-corporation's earningsPress ReleaseFinancial Institution Letters.    

Fed Releases Study on Payments within the United States

On July 21, the Fed released a study providing insights into payments within the United States.  ReleaseResearch.  

Rating Agency Developments

On July 24, S&P issued a request for comment on changes to methodology and assumptions for assessing Japanese RMBSReport.

On July 24, Fitch issued Asia-Pacific Consumer ABS ratings criteria.  Report.

On July 24, Fitch issued UK whole business securitizations ratings criteria.  Report.

On July 21, DBRS issued its methodology for North American commercial mortgage servicer evaluations.  Report.                  

On July 21, DBRS issued its methodology for stability and sustainability of structured income fund evaluations.  Report.

 Note: Free registration is required for rating agency releases and reports.
Distressed Debt and Restructuring Developments

Law360: Rakoff's Foreign Fund Clawback Ruling Has Limitations

On July 6, Jed S. Rakoff, U.S. district judge for the Southern District of New York, declined to extend the reaches of Section 550(a) of the Bankruptcy Code abroad to permit the recovery of funds that were alleged to be fraudulently obtained from Bernard L. Madoff Investment Securities LLC in connection with Bernard Madoff's Ponzi scheme.  The decision involves the attempted extraterritorial application of Section 550(a), which allows a trustee to recover "property transferred ... to the extent that a transfer is avoided" under bankruptcy law.  For the complete Law360 article, please click here.

Investment Management

SEC Adopts Amendments to Rules Governing Money Market Mutual Funds

On July 23, the SEC adopted amendments to the rules that govern money market mutual funds.  The amendments make structural and operational reforms to address risks of investor runs in money market funds, while preserving the benefits of the funds.  Press Release.

RMBS and Other Securities Litigation

SEC Sends Wells Notice to S&P Concerning MBS Ratings

On July 23, S&P's parent company, McGraw Hill Financial Inc., disclosed that it received a Wells notice indicating that the SEC's enforcement staff had made a preliminary determination to recommend that the SEC institute an enforcement action against S&P alleging violation of federal securities laws with respect to S&P's ratings of six commercial MBS transactions in 2011 and public disclosures made by S&P regarding those ratings thereafter.  S&P will have the opportunity to respond to provide its perspective and to address the issues raised by the enforcement staff before any enforcement proceeding is initiated.  Press Release.   

Morgan Stanley Settles RMBS Charges with SEC

On July 24, the SEC announced that it had charged three Morgan Stanley entities with misleading investors with regard to two RMBS securitizations that the firms underwrote, sponsored and issued and that the firm agreed to settle the charges.  In the cease and desist order memorializing the settlement, the SEC alleged that Morgan Stanley misrepresented the current and historical delinquency status of the mortgage loans underlying the securitizations.  The SEC alleged that these misrepresentations violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.  Morgan Stanley agreed to settle the charges without admitting or denying wrongdoing.  As part of the settlement, Morgan Stanley agreed to cease and desist further violations of §§ 17(a)(2)-(3) and to pay US$275 million in disgorgement, prejudgment interest and penalties, which will be placed in a Sarbanes-Oxley Fair Fund for distribution to investors.  Press Release.  Order     

Court Grants in Part and Denies in Part Nomura's Motion to Dismiss Trustee Repurchase Action

On July 18,  Justice Marcy Friedman of the New York County Supreme Court, Commercial Division, granted in part and denied in part Nomura Credit & Capital Inc.'s motion to dismiss claims brought by HSBC, as Trustee for the NAAC 2006-AF2 RMBS Trust, seeking damages, specific performance and indemnification for alleged breach of contract.  Relying on her order from a prior case involving Nomura, Justice Friedman held that the causes of action for damages and specific performance were adequately pled to the extent they were based on Nomura's alleged breaches of representations and warranties regarding mortgage loans.  Justice Friedman held that the relief available to the plaintiff was limited, by operation of the sole remedy provision of the parties' contract, to specific performance of the repurchase protocol or damages consistent with the protocol's terms.  She thus dismissed plaintiff's cause of action seeking rescissory damages.  Justice Friedman also rejected the plaintiff's argument that alleged willful misconduct rendered the sole remedy provision unenforceable, holding both that plaintiff failed to adequately allege intentional wrongdoing by Nomura and that the sole remedy provision was not the type of exculpatory clause that could be rendered unenforceable by willful misconduct.  Finally, Justice Friedman rejected plaintiff's request for attorneys' fees, holding that the indemnification provision in the parties' contract did not clearly provide for fee shifting in lawsuits between the parties.  Order.   

Court Grants in Part RBS Motion for Summary Judgment in Repurchase Action

On July 23, Judge William Conley of the Western District of Wisconsin granted in part and denied in part RBS Securities Inc.'s motion for summary judgment in a suit brought by CUNA Mutual Group seeking to rescind the purchase of fifteen RMBS certificates.  Judge Conley granted RBS's motion for summary judgment as to nine of the fifteen RMBS certificates on the ground that CUNA Mutual's claims were time-barred by Wisconsin's six-year statute of limitations.  He also granted summary judgment to RBS in connection with CUNA Mutual's allegations of misrepresentations concerning compliance with underwriting guidelines, finding that CUNA Mutual presented insufficient evidence to allow a trier of fact to conclude that it actually relied on any of those representations.  Judge Conley similarly granted summary judgment to RBS in connection with CUNA Mutual's allegations of misrepresentations concerning owner occupancy status, finding that CUNA Mutual had not submitted adequate evidence of any misstatement by RBS of the owner occupancy ratios, which were based on occupancy information provided by the borrowers.  As to the six certificates remaining in the lawsuit, CUNA Mutual is allowed to proceed on its claim for rescission based on allegations that RBS misrepresented the LTV and CLTV ratios of the collateral pools.  Finally, Judge Conley denied a series of discovery and sanctions motions raised by both parties.  The case is scheduled to proceed to trial on August 4.  Order

European Financial Industry Developments

Central Securities Depositories Regulation (CSDR) Update

On July 23, the Council of the EU published a press release announcing that it had adopted the CSDR on improving securities settlement and regulating central securities depositories.

The European Commission published a letter on July 23 (dated June 23, 2014) to ESMA setting out a provisional request for technical advice concerning possible delegated acts relating to certain settlement discipline measures and aspects relating to supervisory co-operation under the CSDR.

The letter attaches two formal mandates for technical advice to assist the Commission in preparing delegated acts as required by Articles 7 (penalties for settlement fails) and 14 (supervisory co-operation) of the CSDR.

The commission has requested ESMA to provide its technical advice nine months after the CSDR enters into force.  Press ReleaseLetterFormal Mandates.   

ESMA Discussion Paper on Calculation of Counterparty Risk by UCITS for OTC Derivatives Subject to EMIR Clearing

On July 23, ESMA published a discussion paper on how the limits on counterparty risk in centrally cleared OTC derivative transactions under the UCITS IV Directive should be calculated, and whether the same rules for both OTC transactions that are centrally cleared and for exchange-traded derivatives (ETDs) should be applied.

The UCITS IV Directive allows UCITS to invest in both ETDs and OTC derivatives, but only investments in OTC derivatives are currently subject to counterparty risk exposure limits.

The consultation closes on October 22, 2014.  ESMA will use the feedback to determine its final views on the appropriate way forward, including a possible recommendation to the European Commission on a modification of UCITS IV.  Discussion Paper.   

Reviews into LIBOR, EURIBOR and TIBOR

On July 22, the International Organisation of Securities Commissions (IOSCO) published a Web page on its review of the implementation of IOSCO's principles for financial benchmarks by administrators of the London Interbank Offered Rate (LIBOR), the Euro Interbank Offered Rate (EURIBOR) and the Tokyo Interbank Offered Rate (TIBOR).  IOSCO found that the three administrators have made significant progress in implementing most of the principles.  However, further work is needed on implementing the principles on benchmark design, data sufficiency and transparency of benchmark determinations.  

Also on July 22, the Financial Stability Board (FSB) published a report prepared by the Official Sector Steering Group (OSSG) of regulators and central banks on reforming major interest rate benchmarks. The report was based on the March 2014 report of the Market Participants Group, a group of private sector experts asked by the OSSG to identify additional benchmark rates and to analyze transition issues arising from a move to an alternative rate.  It was also based on the IOSCO review.

In the report, the OSSG recommends a multiple-rate approach that involves: (i) strengthening the existing IBORs (the collective term used by the FSB for each of LIBOR, EURIBO and TIBOR) and other potential reference rates based on unsecured bank funding costs by underpinning them to the greatest extent possible with transactions data; and (ii) developing alternative, nearly interest-risk free reference rates.  Web PageFSB ReportMarket Participants Group Report.   

Amendments to Offshore Fund Rules to Reflect Finance Act 2014 AIFM Partnership Tax Changes

Regulations amending the Offshore Funds Regulations 2009 (the 2009 Regulations) to reflect the Finance Act 2014 changes to the taxation of alternative investment fund managers operating as partnerships (AIFM firms) were made on July 21 and have effect for disposals made on or after August 12, 2014.  The changes to the taxation of AIFM firms permit AIFM firms to elect for all or part of a partner's "relevant restricted profit" to be allocated to the AIFM firm rather than from part of the partner's profit share.  Accordingly, the partner is not subject to tax on the profit. Instead, the AIFM is treated as a partner in the AIFM firm and is subject to income tax at the additional rate (currently 45 percent) on the allocated amount.  The partner is subsequently subject to tax on the amount that vests, but will receive a tax credit for the tax paid by the AIFM firm.  Regulations.  

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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