Orrick's Financial Industry Week in Review - July 22, 2013

by Orrick, Herrington & Sutcliffe LLP
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Financial Industry Developments

SEC and EU Supervisory Cooperation for Asset Management Industry

On July 19, the SEC announced that it signed various memoranda of understanding with the financial regulators of 25 member states of the EU and 3 regulators of the European Economic Area as part of a long-term strategy to improve oversight of certain entities in the asset management industry that operate across national borders.  SEC Release.  Cooperative Arrangements Fact Sheet.   

Real Estate Mortgage Excess Servicing Spread is a Real Estate Asset for REIT Purposes

On July 12, the IRS released a private letter ruling issued on April 12, 2013, ruling that certain real estate mortgage excess servicing spread would constitute a real estate asset, and that income received from the spread would be treated as interest on obligations secured by mortgages on real property, for purposes of the tax rules governing REITs.  This ruling is similar in many respects to another ruling issued in May 2012.  Private letter rulings are not binding on the IRS other than with respect to the taxpayer to whom it is addressed, but REITs may find these rulings useful in analyzing tax issues associated with real estate mortgage excess servicing spreads.  IRS Private Letter Ruling 201328018 (April 12, 2013)IRS Private Letter Ruling 201234006 (May 24, 2012)

Treasury and IRS Extend FATCA Deadlines

Notice 2013-43, released on July 12, 2013, announces the Internal Revenue Service's (the IRS) and the Department of the Treasury's intent to amend final Treasury regulations implementing the U.S. Foreign Account Tax Compliance Act (FATCA) to (i) extend certain implementation dates for withholding and account due diligence and (ii) specifically identify jurisdictions treated as having in force intergovernmental agreements (IGAs) for the implementation of FATCA, including jurisdictions that have signed IGAs but have not yet brought those IGAs into force.  Orrick covered the topic in a recent alert.  Notice 2013-43.  

SEC Lifts Ban on General Solicitation, Adopts "Bad Actor" Disqualification Rules and Proposes Amendments to Form D Filings

On April 5, 2012, the Jumpstart Our Business Startups Act (the JOBS Act) was enacted.  Title II of the JOBS Act mandated the Securities and Exchange Commission to amend applicable rules within 90 days of its enactment (i.e., July 5, 2012) in order to eliminate the prohibitions against general solicitation or general advertising in Rule 506 of Regulation D under the Securities Act of 1933, as amended, and under Rule 144A under the Securities Act.  In August 2012, the Commission proposed a new Rule 506(c) and an amendment to Rule 144A to implement Title II.  During an open meeting on July 10, 2013, the Commission issued two releases (33-9414 (bad actor) and 33-9415 (Rule 506, Rule 144A and Form D)) which adopted new rules.  For more information on the adopted rules, please click here.  

Rating Agency Developments

On July 19, Moody's issued its U.S. RMBS surveillance methodology.  Moody's Report

On July 19, DBRS released its criteria for rating guarantees and other forms of explicit supportDBRS Report

On July 19, KBRA released its financial guaranty rating methodology.  KBRA Report

On July 19, Fitch released its national scale criteria for rating money market fundsFitch Report

On July 17, Fitch released its criteria for evaluating third-party partial credit guaranteesFitch Report

On July 16, Fitch released its criteria for rating U.S. RMBSFitch Report

Note: Free registration is required for rating agency releases and reports.

Distressed Debt and Restructuring Developments

The City of Detroit Files for Chapter 9 Bankruptcy Protection

On July 18, the City of Detroit filed for protection under chapter 9 of the Bankruptcy Code, making Detroit the largest municipality to file for chapter 9 relief in United States history.  Detroit is seeking to restructure approximately $18 billion in accrued obligations, consisting of approximately $11.9 billion in unsecured obligations and $6.4 billion in secured obligations.  Prior to the bankruptcy filing, the City offered to pay unsecured creditors a pro rata distribution of $2 billion in principal amount of interest-only, limited recourse participation notes. 

Detroit filed several significant motions in its first days in bankruptcy.  They included:

Bankruptcy Judge Steven W. Rhodes has scheduled a "first day" hearing on these and other matters for July 23.  We will continue to update developments in the Detroit Chapter 9 case.

RMBS and Other Securities Litigation

Federal Court Denies S&P's Motion to Dismiss $5 Billion RMBS Fraud Suit

On July 16, Judge David O. Carter of the Federal District Court for the Central District of California denied Standard & Poor's Financial Service LLC's (S&P) motion to dismiss the U.S. government's $5 billion fraud suit alleging that S&P intentionally issued false credit ratings of mortgage backed securities.  In denying the motion, the court rejected S&P's arguments that its statements about the securities were "puffery," that the complaint fails to plead facts showing that the credit ratings were false or misleading, and that the complaint fails to plead scienter.  The government's claims are for civil penalties for alleged violations of criminal mail fraud, wire fraud and financial institution fraud statutes.  Decision.  Orrick covered this recent development and the Financial Institutions Reform Recovery Enforcement Act (FIRREA) here

Morgan Stanley's Motion to Dismiss $757 Million RMBS Suit Denied in Part

On July 13, Justice Eileen Bransten of the New York Supreme Court denied Morgan Stanley's motion to dismiss MetLife's common law fraud and fraudulent inducement claims.  MetLife alleges that Morgan Stanley knowingly misrepresented the quality of over $757 million RMBS that it underwrote or sponsored.  The court held that MetLife sufficiently alleged reasonable reliance, a material misrepresentation, scienter and loss causation.  However, Justice Bransten granted the motion to dismiss as to claims brought by the Connecticut subsidiary of MetLife, finding the claims barred by Connecticut's three-year statute of repose for fraud claims. Decision.

SEC Suit Against Radius Capital, CEO Dismissed in Part as Untimely

On July 15, U.S. District Judge John Steele of the Middle District of Florida granted in part a motion to dismiss the SEC's claims against now-defunct Radius Capital and its former CEO, Robert DiGiorgio.  The SEC alleges misrepresentations in connection with $23 million in mortgage-backed securities issued in 2005 and 2006.  Judge Steel held that the SEC's civil claims relating to securities issued before March 2006 were untimely when brought by the SEC in March of 2011.  Decision.

European Financial Industry Developments

AIFMD: Countdown to Compliance

The July 22 deadline for EU Member States to transpose the Alternative Investment Fund Managers Directive (AIFMD) into national law has arrived.  While the competent authorities in the UK and Germany have made significant progress in implementing new regulations to transpose the AIFMD into national law, other EU member states, including France and Italy, are currently consulting regarding the relevant implementation rules.  It is unclear whether those Member States will be ready in time.

In the UK, the Financial Conduct Authority (FCA) provided clarity by setting out its response to its November 2012 and March 2013 consultation papers and confirmed the FCA's final rules for implementation of the AIFMD in its June 28 policy statement (PS13/5) (Policy Statement).  The rules in the Policy Statement supplement the UK's Alternative Investment Fund Managers Regulations 2013, which were approved by the Delegated Legislation Committee in the UK on July 3.

For further details on the key provisions of the AIFMD and the specific measures implemented by Member States in an effort to transpose the AIFMD into national laws, please click here.

ESMA Finalises Cooperation Agreements for Alternative Investment Funds

On July 18, the European Securities and Markets Association (ESMA) published a press release stating that it has approved seven Memoranda of Understanding (MoUs) between EU securities regulators and non-EU authorities granting responsibility for the supervision of alternative investment funds (AIFs).  The MoUs are applicable from July 22 and will enable cross-border marketing of AIFs to professional investors between jurisdictions.

ESMA's Board of Supervisors approved MoUs with authorities from the Bahamas, Japan, Malaysia, Mexico and the United States, including the Commodity Futures Trading Commission.  ESMA has now negotiated 38 MoUs on behalf of the 31 EU/EEA authorities.

The Alternative Investment Fund Managers Directive (AIFMD) requires that MoUs are entered into between the EU and non-EU authorities. MoUs allow alternative investment fund managers (AIFMs) from non-EU countries access to EU markets or to perform fund management by delegation from EU AIFMs.  The MoUs cover non-EU AIFMs that market AIFs in the EU and EU AIFMs that manage or market AIFs outside the EU.  The MoUs also cover cooperation in the cross-border supervision of depositaries and AIFMs' delegates.  Press ReleaseMemoranda of Understanding

ESMA Consults on Non-EU Counterparties OTC Derivative Transactions

On July 17, the European Securities and Markets Authority (ESMA) launched a consultation on draft regulatory technical standards (RTS).  The consultation is aimed at implementing the provisions of the European Markets Infrastructure Regulation (EMIR) related to OTC derivative transactions by non-EU counterparties and at preventing attempts by non-EU counterparties to evade EMIR's provisions.

The consultation paper clarifies conditions where EMIR's provisions regarding central clearing or risk mitigation techniques applies to OTC derivatives by two non-EU counterparties which have a direct, substantial and foreseeable effect in the EU.  The RTS would only apply when (i) two counterparties to the same transaction are established outside the EU; (ii) their jurisdictions' rules are not considered equivalent to EMIR; and (iii) where either a) one of the two non-EU counterparties is guaranteed by an EU financial counterparty for at least €8 billion of OTC derivatives entered into and for an amount of at least 5% of the OTC derivatives exposures of the EU financial counterparty, or b) the two non-EU counterparties execute transactions via their EU branches.  Consultation.

EBA Report on Risks and Vulnerabilities of the EU Banking System

On July 17, the European Banking Authority (EBA) published a report on risks and vulnerabilities of the EU banking system.  The report considered EBA key risk indicators and EBA risk assessment questionnaires for banks and market analysts.  The report highlighted the following:

    • Increasing uncertainty about the quality of banks' assets and valuation.
    • Significant strategic and implementation challenges. This includes the CRD IV reforms and proposals to establish a single supervisory mechanism for banking union member states.
    • Detrimental business practices of EU banks such as product misselling and failures regarding rate benchmark setting.  This will require heightened supervisory oversight and improvements in institutions' risk management functions, compliance procedures and risk culture to improve consumer relationships with banks.  Report.

 

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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