Bridging the Week - April 2016

Katten Muchin Rosenman LLP

GAO Claims US Financial Services Regulation Still Complex and Fragmented

Last week, the US Government Accountability Office reported that US oversight of financial services entities and products has not meaningfully improved since its issuance of a comprehensive study more than seven years ago that warned that the US financial regulatory system “appears to be ill-suited to meet the nation’s needs in the 21st century” because of its high level of complexity and overlap.

In its latest study, GAO said that the US financial regulatory system continues to be “complex, with responsibilities fragmented among multiple agencies that have overlapping authorities.”(Click here to access GAO’s 2009 study.)

GAO noted that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act introduced a number of reforms to improve coordination among financial regulators. These included the establishment of the Financial Industry Oversight Council and the Office of Financial Research. However, said GAO, “collaborative efforts have not been sufficient, and FSOC’s authorities are limited and unclear.” According to GAO, this has caused “inefficiencies in regulatory processes, inconsistencies in how regulators oversee similar types of institutions, and differences in the levels of protections afforded to consumers.”

GAO identified inconsistencies in the examination of depository institutions by different regulators, the lack of uniformity in insurance regulation and the sometimes duplicative and inconsistent regulation of securities and derivatives market participants by different regulators as prime examples of problematic oversight.

As a specific evidence of its observations, GAO noted that the Commodity Futures Trading Commission and the Securities and Exchange Commission both were given oversight over elements of swaps trading under Dodd-Frank. In response, each agency has endeavored to coordinate with the other to develop applicable regulation, as required under law. However, there have been subtle but important differences in approaches to regulation (e.g., the definition of a US person under CFTC and SEC cross-border provisions), and delays by the SEC in finalizing rules that market participants fear “could lead to operational challenges …, as well as uncertainty and regulatory inefficiencies and burden.”

GAO also observed that the complexity of the US financial regulatory system complicates coordination on some issues with international regulators because there is no unified US view.

In response, GAO posited that Congress “should consider whether additional changes to the financial regulatory structure are needed to reduce or better manage fragmentation and overlap,” including whether a “number of federal agencies” should be consolidated. GAO also suggested that Congress should consider whether “legislative changes are necessary to align FSOC’s authorities with its mission to respond to systemic risk.”

GAO is an independent, non-partisan federal agency that supports Congress in ensuring that US government funds are spent “efficiently and effectively.” In 2010, GAO issued a study identifying overlaps and inefficiencies in the regulation of financial markets by the SEC and CFTC. (Click here to a copy of this study.)

My View: Just like GAO’s recommendations mostly fell on deaf ears during the height of the financial crisis in 2009, its current recommendations are likely to be similarly ignored in the highly partisan environment of Washington, DC, today. This is a shame. The US financial regulatory system is broken and inefficient, and clearly needs fixing. As GAO observed in 2009, “[m]uch of [today’s] structure has developed as the result of statutory and regulatory changes that were often implemented in response to financial crises or significant developments in the financial services sector.” The US financial regulatory system has not benefited from a holistic examination of what makes most sense today, let alone what might make most sense tomorrow. Oversight of financial regulators is also spread among too many congressional committees, and this impedes thoughtfulness and rationalization. But it is critical in order for the United States to be competitive internationally in financial services for such a reflection to occur and oversight to be rationalized. Maybe next year. We can only hope. 

CFTC Commissioner Calls for Regulators to “Do No Harm” in Development of Distributed Ledger Technology; Other Regulators Weigh in Too:

J. Christopher Giancarlo, Commissioner of the Commodity Futures Trading Commission, called for regulators, including the CFTC, to “do no harm” in permitting the new blockchain or distributed ledger technology to develop.

DLT, introduced in connection with transactions involving Bitcoin, references a public ledger of all transactions referencing an item that is automatically updated to include the latest and all prior transactions. A DLT should not be subject to tampering or independent revision.

According to Mr. Giancarlo, the model for a “do no harm” regulatory approach is the path regulators followed during the initial days of the Internet. According to Mr. Giancarlo, back in the 1990’s,

a Republican Congress and the Clinton administration established a set of foundational principles: the Internet was to progress through human social interaction, voluntary contractual relations and free market. Governments and regulators were not to harm the Internet’s continuing evolution.

As a result of this approach, claimed Mr. Giancarlo, the Internet flourished, “created jobs, increased productivity and fostered innovation and consumer choice.” Mr. Giancarlo argued that, by following the same approach now, the DLT can most effectively be permitted to evolve in a similar fashion.

To accomplish this, US and foreign regulators should “coordinate to create a principles-based approach for DLT oversight in order to provide the flexibility, certainty, and harmonization necessary for this technology to flourish.” The CFTC itself, said Mr. Giancarlo, should examine and revise it rules – such as its recordkeeping requirements – to ensure they are technologically neutral to avoid inhibiting DLT development.

In a separate speech before SEC-Rock Center for Corporate Governance’s Silicon Valley Initiative, May Jo White, Chairperson of the Securities and Commission, indicated that her agency is currently considering whether certain blockchain applications may require registration as transfer agents or clearing agencies. She observed that the SEC recently reviewed the registration statement of Overstock, Inc., which is seeking to offer and sell digital securities that trade and settle entirely on the blockchain, bypassing intermediaries.

Relatedly, last week the office of the Comptroller of the Currency issued a paper articulating standards it will apply to support “responsible innovation” in the federal banking system. These principles included supporting “responsible innovation” and fostering “an internal culture receptive to responsible innovation.”

Legal Weeds: The CFTC has previously determined that Bitcoin and other virtual currencies are “commodities” under applicable law. (Click here for details in the article, “CFTC Says Virtual Currencies Are a “Commodity” Under Federal Law, Files Charges Against Coinflip for Operating an Unregistered Bitcoin Options Trading Platform” in the September 20, 2015 edition of Bridging the Week.) This is likely a correct interpretation as under applicable law, commodities are broadly defined as any goods, articles, services, rights and interests “in which contracts for future delivery are presently or in the future dealt in” with two exceptions: onions and motion picture box office receipts, or any “index, measure, value or data related to such receipts.” Moreover, with limited exceptions (most notably, involving securities), the CFTC has exclusive jurisdiction under applicable law with respect to all trading of commodities of the nature of options, futures and swaps, including over most market participants. It is not certain, however, that the New York State Department of Financial Service is prepared to restrict its regulation of virtual currency transactions and intermediaries through imposition of its so-called “BitLicense” and other requirements to the extent such obligations impact activities and persons under the exclusive jurisdiction of the CFTC. It is also not clear how states that adopt their own BitLicense-type provisions will address CFTC exclusive jurisdiction regarding certain aspects of digital currency businesses (click here to access the proposed model state BitLicense equivalent law, the Regulation of Virtual Currencies Act). It will be interesting to watch this space going forward to see whether a jurisdiction fight emerges. (Click here to review the relevant provision of law related to the definition of a commodity and here for the scope of the CFTC’s exclusive jurisdiction. Click here for background on the NYS Department of Financial Services’ “BitLicense” requirements in the article, “NYDFS Issues BitLicense Framework for Regulating Virtual Currency Firms” in the June 7, 2015 edition of Bridging the Week.)


  • ESMA Fines Trade Repository for Not Having Systems With Data Immediately Accessible by Regulators: The European Securities and Markets Authority brought its first legal action against a trade repository for allegedly failing to institute systems able to provide regulators with direct and immediate access to derivatives trading data, as required by applicable regulation. The trade repository was DTCC Derivatives Repository Limited, which was fined €64,000 by ESMA for committing the alleged violations from March 21, 2014, through December 15, 2014. According to ESMA, DTCC also failed to advise ESMA in a “timely manner” of the delays it was experiencing once it was aware of its systems’ deficiencies, and did not put in place an adequate action plan to fix its issues for three months. DTCC may, within two months, file an appeal of ESMA’s decision to the Board of Appeals of the European Supervisory Authorities. In March 2015, the Commodity Futures Trading Commission fined ICE Futures U.S. US $3 million for filing with it allegedly inaccurate or incomplete reports related to trading activity, prices and delivery notices from October 2012 to at least May 2014. (Click here for details in the article, “ICE Futures Fined US $3 Million by CFTC for Reporting Errors and Untimely Response to Inquiries” in the March 22, 2015 edition of Bridging the Week.)
  • CME Group Sanctions Eight Companies for Non-Bona Fide EFRPs; IFUS Sanctions an Individual for Disruptive Trading: CME Group resolved eight disciplinary actions involving alleged violations of its exchange for related position requirements by assessment of aggregate fines totaling US $174,500. In many of the actions, the alleged violation involved only one transaction; for these matters, the defendant was assessed a fine of US $15,000. Six of the actions were against non-members, while only two involved members. In most of the matters, the defendant was charged with entering into an EFRP without a bona fide transaction involving a transfer of a related position (e.g., transfer of a cash commodity). Separately, ICE Futures U.S. agreed to resolve allegations against an individual for alleged spoofing-type conduct by his disgorgement of trading profits of approximately US $8,000 and a fine of approximately US $82,000. According to IFUS, the defendant engaged in a pattern of trading from March 2015 to May 2015 in Coffee “C” futures, where he would place small orders on one side of the market and large orders on the other side. On numerous occasions, claimed IFUS, “the small order transacted and [the respondent] would cancel the larger order on the opposite side of the market.” The defendant also agreed to a 10-day IFUS trading suspension to resolve this matter.

Compliance Weeds: In connection with EFRPs, one party must sell the exchange contract and buy approximately the same quantity of the related position (or the market exposure associated with the related position), while the other party must buy the exchange contract and sell the same approximate quantity of the related position or associated market exposure. The related position must be the cash commodity associated with the exchange contract or a by-product, a related product or an over-the-counter derivative instrument of such commodity that is reasonably correlated to the exchange contract. EFRPs must result in a real transfer of a cash commodity between the parties or a legal binding agreement between the parties governing the related position consistent with prevailing market conventions. (Click here for CME Group guidance regarding EFRPs, here for ICE Futures U.S. guidance, and here for CBOE Futures Exchange guidance.)

  • SEC Chairperson Muses About Mutual Fund Directors’ Responsibilities and Potential Enforcement Interest: Mary Jo White, Chairperson of the Securities and Exchange Commission, said in a speech before the Mutual Fund Directors Forum 2016 Policy Conference that “most” directors of mutual funds “should not fear enforcement.” This is because, she noted, “judgments made in good faith based on responsibly performing their duties will not be second guessed.” However, she cautioned, “being a director … does not provide immunity from charges. When directors fail to perform their duties they should expect action to punish and deter such conduct.” Ms. White referenced the facts underlying two recent SEC enforcement actions as example of the type of conduct where directors might expect to be charged for wrongful conduct by the SEC: one where the directors allegedly did not, as required by law, approve any fair valuation methodology for securities in a fund and review the use of an approved methodology on an ongoing basis, and another where the directors did not request and consider information that is “reasonably necessary” for the board to consider an advisory contract – a core requirement of directors, according to Ms. White. (Click here to access the SEC order of settlement In the Matter of Kenneth Alderman and here to access the SEC order of settlement In the Matter of Commonwealth Capital Management, the two matters referenced by Ms. White.) Ms. White acknowledged that these cases “generated some controversy” but claimed that “the facts involved should reassure conscientious directors." According to Ms. White, “[t]he message of these cases is simply that independent directors must be familiar with and carry out their responsibilities.” (Click here for further details regarding the SEC's Commonwealth Capital Management order in the article, “Investment Adviser and Mutual Fund Board Members Sued by SEC for Inadequate Advisory Contract Approval Process” in the June 21, 2015 edition of Bridging the Week.)

Compliance Weeds: The requirement that an investment company’s board members request and evaluate information “as may be reasonably necessary” to appoint an adviser is established by statute (Section 15(c) of the Investment Company Act; click here to access). Thus the failure of board members to follow this requirement, including following up when incomplete information was provided in response to a request for information, may be deemed a violation of law, as the SEC charged in the second matter referenced by Chairperson White. However, not following up on incomplete or facially inaccurate information in response to any internal investigation or review, or due diligence inquiry, could cause later regulatory issues for any regulated firm or person, whether the initial request was mandated by law or not, if something bad happens and later it is thought that review of the missed information might have “reasonably” prevented a regulatory incident. However, the determination of reasonableness will likely only be determined after the fact. Be mindful!

  • ISDAfix Class Action Authorized to Proceed by Federal Court: A US federal court in New York City declined to grant a request by 14 banks and ICAP Capital Markets LLC to dismiss a putative class action lawsuit against them alleging, among other things, that they colluded to manipulate the US dollar ISDAfix benchmark interest rate from January 1, 2006, through January 2014. (Click here for details regarding the original lawsuit in the article, “Alaska Pension Fund Sues 14 Financial Institutions Over Alleged ISDAfix Manipulation” in the September 7, 2014 edition of Bridging the Week. ISDAfix is the benchmark most commonly referenced to value cash-settled interest rate swaptions upon their expiration.) In a motion to dismiss plaintiffs’ action, defendants had specifically objected to plaintiffs’ claims based on alleged violations of federal anti-trust law and various state-law claims. The court held that plaintiffs had “plausibly” described a conspiracy by the defendants to restrain trade and that they suffered an antitrust injury and were suitable plaintiffs to pursue the alleged antitrust violations – thus satisfying their obligations for the lawsuit to proceed at this time. According to the court, “the Amended Complaint in these cases alleges that Plaintiffs ‘are purchasers’ of Defendants’ products ‘who allege being forced to pay supra-competitive prices as a result of [Defendants’] anticompetitive conduct’.” The court also denied defendants’ motion to dismiss causes of actions based on breach of contract and unjust enrichment, except for claims against one defendant (Nomura Holdings Inc.). It granted, however, defendants’ request to dismiss plaintiffs’ breach of tortious interference and breach of implied faith claims under state law.

And more briefly:

  • No Fingerprint Rule for Foreign Natural Persons Finalized by CFTC: The Commodity Futures Trading Commission approved a new rule permitting certain foreign natural persons not to have to submit fingerprints to it in connection with a registration application. Instead, such person’s sponsoring firm would complete a criminal history background check. When the new rule is effective on May 2, 2016, it will supplant existing fingerprint relief to certain foreign natural persons under CFTC staff-issued no-action relief.
  • IFUS Proposes to Expand FCMs’ AML Responsibilities Under Its Rules: ICE Futures U.S. proposes to amend one of its rules to make it clear that futures commission merchants must maintain anti-money laundering programs that comply with all applicable requirements. The current rule only requires FCMs to maintain AML programs that comply solely with the Bank Secrecy Act and economic sanctions regulations (click here to access IFUS Rule 6.44). Absent objection by the Commodity Futures Trading Commission, the new rule will be effective April 13, 2016
  • US Supreme Court Declines to Consider SEC Administrative Forum Selection: The US Supreme Court refused to hear a lawsuit brought by Laurie Bebo, challenging the legality of a decision of the Securities and Exchange Commission to bring an enforcement action against her in an SEC administrative forum as opposed to a federal court. A US appellate court had previously ruled that Ms. Bebo must first raise her challenge in an appeal to the SEC and then to a US appellate court, before pursuing federal court remedies. (Click here for details on this action in the article, “Appellate Court Rules Plaintiff Cannot Challenge SEC Forum Choice in Federal Court at This Time” in the August 30, 2015 edition of Bridging the Week.)
  • ICE Futures Europe Updates Guidance on Position Limits and Accountability Levels: ICE Futures Europe has updated its guidance on position, expiry and delivery limits, and accountability levels to reflect the introduction of various new futures and options contracts. Under the terms of an amendment to prior no-action relief granted by staff of the Commodity Futures Trading Commission, ICE Futures Europe is obligated to maintain and enforce position limits and accountability levels on certain oil and refined product (e.g., soybean oil) contracts that are comparable to those applied by a CFTC-designated contract market (click here to access the relevant CFTC amendment to no-action letter).
  • OFAC Blocked Persons and Specially Designated Nationals List Revised: The Office of Foreign Assets Control of the US Department of Treasury has updated its list of specially designated nationals and blocked persons. Registered entities are generally prohibited from conducting business with persons included on these lists.
  • IOSCO Updates Information Repository of Central Clearing Requirements by Jurisdiction: The International Organization of Securities Commissions has issued an update to its information repository, setting forth clearing obligations for over-the-counter derivatives by jurisdiction. The repository is organized by three asset classes: interest rate, credit and foreign exchange

For more information, see:

CFTC Commissioner Calls for Regulators to “Do No Harm” in Development of Distributed Ledger Technology; Other Regulators Weigh in Too:

See also:
OCC Report:
Press Announcement, Overstock, Inc:
Speech of Mary Jo White:

CME Group Sanctions Eight Companies for Non-Bona Fide EFRPs; IFUS Sanctions an Individual for Disruptive Trading:

CME Group actions:
BOCI Global Commodities:
Cargill International:
HSH Nordbank:
Oak Futures:
Strong Petrochemical:
UNIPEC Singapore:
United Overseas Bank:

IFUS action:
Alan Rabinowitz:

ESMA Fines Trade Repository for Not Having Systems With Data Immediately Accessible by Regulators:

GAO Claims US Financial Services Regulation Still Complex and Fragmented:

ICE Futures Europe Updates Guidance on Position Limits and Accountability Levels:

IFUS Proposes to Expand FCMs’ AML Responsibilities Under Its Rules:

IOSCO Updates Information Repository of Central Clearing Requirements by Jurisdiction:

ISDAfix Class Action Authorized to Proceed by Federal Court:

No Fingerprint Rule for Foreign Natural Persons Finalized by CFTC:

OFAC Blocked Persons and Specially Designated Nationals List Revised:

SEC Chairperson Muses About Mutual Fund Directors’ Responsibilities and Potential Enforcement Interest:

US Supreme Court Declines to Consider SEC Administrative Forum Selection:

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.

© Katten Muchin Rosenman LLP | Attorney Advertising

Written by:

Katten Muchin Rosenman LLP

Katten Muchin Rosenman LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.