Orrick's Financial Industry Week in Review - October 15, 2012

by Orrick, Herrington & Sutcliffe LLP

Financial Industry Developments


CFTC Guidance on Commodity Pool Registration Exclusion

On October 11, the CFTC issued a “no-action” letter to ASF and SIFMA with respect to the funds being treated as commodity pool under CFTC regulations and the Commodities Exchange Act.  The letter indicates that (i) certain securitization vehicles should not be included within the definition of “commodity pool” and (ii) operators of those vehicles should not be included within the definition of “commodity pool operator” .  The letter includes a set of criteria which, if satisfied, would result in CFTC staff not considering a vehicle a commodity pool.  CFTC Letter.

FDIC, Fed, and OCC Rules for Large Bank Stress Tests

On October 9, the FDIC, Fed, and OCC published final rules, required by section 165(i) of the Dodd-Frank Act, for annual company-run stress testing by covered institutions with total consolidated assets greater than $10 billion.  The final rule requires institutions with assets greater than $50 billion to begin annual stress testing this year.  The rule delays implementation for covered institutions with total consolidated assets between $10 billion and $50 billion until October 2013.  The FDIC also approved a final rule that refines the deposit insurance assessment system for insured depository institutions with more than $10 billion in assets. The final rule amends the definitions used to identify concentrations in higher-risk assets to better reflect the risk posed to institutions and the FDIC.  FDIC Release.  Fed Release.  OCC Release.

FHFA Releases Strategic Plan for 2013 – 2017

On October 9, the FHFA released “Preparing a Foundation for a More Efficient and Effective Housing Finance System”, an updated strategic plan for 2013 – 2017.  The four strategic goals of the plan are: (i) safe and sound housing government-sponsored enterprises; (ii) stability, liquidity, and access in housing finance; (iii) to preserve and conserve Fannie Mae and Freddie Mac assets; and (iv) to prepare for the future of housing finance in the U.S.  FHFA Release.

SEC Proposed Rule on Principal Trades with Advisory Clients

On October 9, the SEC proposed an amendment to rule 206(3)-3T under the Investment Advisers Act of 1940, a temporary rule that establishes an alternative means for investment advisers registered with the SEC as broker-dealers to meet the requirements of section 206(3) of the Act when they act in a principal capacity in transactions with certain of their advisory clients.  Comments must be received within 30 days after publication in the Federal Register.  SEC Proposed Rule.

OCC Final Rule on Short-Term Investment Funds

On October 9, the OCC published a final rule that revises the requirements on U.S. banks and federal branches of foreign banks pursuant to 12 CFR 9.18(b)(4)(ii)(B), the short-term investment fund rule.  Under the final rule, a short-term investment fund must: (i) operate with a primary objective to maintain a stable NAV of $1.00 per participating interest; (ii) have a dollar-weighted average portfolio maturity of 60 days; (iii) have a dollar-weighted average portfolio life maturity of 120 days; (iv) adopt portfolio and issuer qualitative standards and concentration restrictions and standards to address contingency funding needs; (v) adopt shadow pricing procedures and calculate the difference on at least a weekly basis; (vi) adopt procedures for stress testing the fund’s ability to maintain a stable NAV and report adverse stress testing results to the managing bank’s senior risk management; (vii) provide monthly disclosures to fund plan participants and the OCC; (viii) adopt procedures that require a bank that administers a fund to notify the OCC before or within one business day after the occurrence of one or more of six specific events; (ix) use mark-to-market value accounting instead of amortized cost accounting if the market value of the portfolio falls below a NAV of $0.995 per participating interest; and (x) adopt procedures to take certain actions if a bank suspends or limits withdrawals and initiates liquidation of the fund as a result of redemptions.  The final rule will be effective on July 1, 2013.  OCC Release.

CFTC Responds to Cleared Swap Reporting Questions

On October 11, the CFTC responded to questions on the reporting of cleared swaps as required under part 45 of the CFTC’s regulations.  CFTC Release.

CFTC Response to Swap Data Reporting Questions

On October 10, the CFTC responded to questions on the timing of when counterparties will be required to report swap pricing and transaction data as required under part 45 of the CFTC’s regulations.  CFTC Release.

Rating Agency Developments


On October 10, DBRS released methodology for structured finance CDO restructurings.  DBRS Report.

On October 5, Moody’s released its approach to rating derivative product companiesMoody’s Report.

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

Asset Management


SEC OCIE Letter on National Exam Program Initiative

On October 9, the SEC’s Office of Compliance Inspections and Examinations (OCIE) sent letters of introduction addressed to the Senior Executives of newly-registered advisers to private funds as part of their nationwide outreach announcing a new initiative under the National Exam Program, in which OCIE will be conducting “focused, risk-based examinations of advisers to private funds.” 

Under this initiative, the exam staff will review one or more high-risk areas of a private fund adviser, which could include marketing materials, conflicts of interest in the portfolio management process, such as investment and trade allocations, safety of client assets in the context of the Advisers Act custody rule, and valuation policies and procedures, especially with regard to illiquid or difficult to value instruments.  As with all OCIE exams, the outcome of the exam could include no findings, an “examination summary letter” of compliance deficiencies, or a referral to the SEC’s Division of Enforcement or another regulator, such as FINRA or a state.  SEC OCIE Letter.

RMBS Litigation


U.S. Sues Wells Fargo Over Allegedly Defective FHA Mortgages

On October 9, the United States Attorney for the Southern District of New York filed suit against Wells Fargo Bank, N.A. in the United States District Court for the Southern District of New York.  The civil suit seeks damages, including treble damages where available, and civil penalties for alleged violations of the False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, breach of fiduciary duty, gross negligence, negligence, unjust enrichment, and payment under mistake in fact.  The Government’s complaint alleges that Wells Fargo, a participant in the Federal Housing Administration’s mortgage lending insurance program, failed to report over 6,000 mortgage loans that were in fact ineligible for FHA insurance.  As a result of Wells Fargo’s alleged misconduct, the Government allegedly paid hundreds of millions of dollars in connection with insurance claims made on these loans.  The alleged defects in connection with Wells Fargo’s origination process – that violations of stated mortgage lending guidelines resulted in poor quality loans – are similar to the allegations that underlie many RMBS investor actions.  Complaint.

Bond Insurer Syncora Sues JPMorgan, Bear Stearns, and EMC Mortgage

On October 5, Syncora Guarantee Inc. filed suit in New York state court against JPMorgan Chase Bank NA, Bear Stearns & Co., Inc., and EMC Mortgage LLC.  Syncora asserts claims of breach of contract, fraudulent inducement, and tortious interference in connection with a 2007 re-securitization of real estate mortgage investment conduits (REMICs) that consisted of certificates from four Bear Stearns RMBS.  The complaint alleges that the defendants misrepresented the quality of the mortgage loans underlying the RMBS and the quality of the due diligence performed in connection with the origination of those loans.  Syncora claims it has paid out over $94 million to insured investors on a transaction that experienced cumulative losses of over $111 million.  Syncora seeks compensatory and punitive damages, reimbursement, and attorneys fees and costs.  Complaint.

European Financial Industry Developments


Consultation on the Recovery and Resolution of Non-Bank Financial Institutions

On October 5, the European Commission published a consultation paper on a possible framework for the recovery and resolution of non-bank financial institutions.  The consultation paper covers three types of institutions and focuses on:

  • central counterparties and central securities depositories (financial market infrastructures);
  • insurance and reinsurance firms; and
  • payment systems and other non-bank financial institutions.  

For each of these groups of financial institutions the consultation paper first looks to ascertain how and when the failure of a financial institution can threaten the stability of the financial markets, and then considers what arrangements could be needed to ensure that such failures are resolved in an orderly manner. 

The initiative follows the adoption, on June 6, of a Commission proposal for an EU framework in this area for banks and investment firms.  The Commission invites responses by December 28.

Short Selling: ESMA Questions and Answers

On October 10, ESMA published a first update to its Questions and Answers on the implementation of the Regulation on short selling and certain aspects of credit default swaps (the Short Selling Regulation).  ESMA’s Questions and Answers provides responses to questions posed by market participants and regulatory authorities, with the aim of promoting the consistent application of the Short Selling Regulation throughout Europe.  The Questions and Answers have been updated in respect of questions related to: 

  • the transparency of net short positions;
  • calculating the net short position;
  • uncovered short sales;
  • the duration adjustment for calculating net short positions in sovereign debt;
  • net short positions when different entities in a group have long or short positions or for fund management activities; and
  • exemption for market making activities and for primary dealers operations.

Bribery Act 2010: Revised Policies on Facilitation Payments, Business Expenditure and Corporate Self-Reporting

On October 9, the Serious Fraud Office (SFO) issued revised policy statements in respect of facilitation payments, business expenditure (gifts and corporate hospitality) and self-reporting.  The changes reflect the SFO’s recent shift back towards its traditional role of investigating and prosecuting serious crime, rather than acting in a more regulatory capacity.  

In summary, the revised statements make the following key points: 

  • facilitation payments are bribes and are illegal under the Bribery Act 2010, irrespective of their size or frequency;
  • although genuine hospitality or promotional business expenditure is an important and well-established part of doing business, it is important to be aware that bribes can be disguised as legitimate expenditure; and
  • the Guidance on Corporate Prosecutions sets out the extent to which self reporting is relevant to the decision to prosecute. Self reporting will not automatically avert prosecution and, even if the SFO does not prosecute reported violations, it can still prosecute unreported violations and provide information to other bodies such as foreign police forces.

FSA Bans and Fines Former Managing Director of Welcome Financial Services Ltd for Market Abuse

The FSA published its final notice dated October 8 in relation to John Blake, the former managing director of Welcome Financial Services Ltd (Welcome).  In its final notice the FSA states that Mr. Blake engaged in market abuse, and has fined him £100,000 and banned him from performing any function relating to a regulated activity. 

Mr. Blake, together with other directors on the board of Welcome, approved Welcome's 2007 annual report, which contained false and misleading statements.  As Welcome was at the time a subsidiary of the (as was) publically listed Cattles plc (which has since been de-listed), the false and misleading statements in the Welcome report were included in Cattles’ 2007 annual report and rights issue prospectus.  The FSA considered that Mr. Blake had been "knowingly concerned" in the failure of Welcome to take reasonable care to organise and control its affairs responsibly and effectively. 

The FSA viewed Mr. Blake's conduct as particularly serious as it took place over a sustained period (approximately 18 months) and had a very serious impact both on Cattles' shareholders (who lost all or virtually all of their investment) and on market confidence.



ABS East 2012: Investor Focused. Investor Driven.

On October 21–23, Orrick will be an Associate level sponsor of this year's IMN's ABS East Conference.  The ABS East 2012 Conference will provide a relevant and timely program that reflects the concerns of the buy side equally along with that of other market participants, thus giving the structured finance investor community a platform to express their views on the market.  On October 22, Orrick Partner Howard Altarescu will moderate a panel on "Private Label RMBS Reform: What is Needed to Restart the Market?"  For more information, please click here.  


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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