Orrick's Financial Industry Week in Review - October 3, 2011

by Orrick, Herrington & Sutcliffe LLP

Financial Industry Developments


FINRA Proposed Rule Change to Market-Wide Circuit Breaker Proposals

On September 27, FINRA filed a proposed rule change with the SEC to: (i) update Rule 6121 (Trading Halts Due to Extraordinary Market Volatility) to reflect changes to market-wide circuit breaker triggers for National Market System stocks and (ii) amend Rule 6440 (Trading and Quotation Halt in OTC Equity Securities) to provide specifically for a halt in trading in all OTC Equity Securities when a market-wide circuit breaker is in effect for NMS stocks. SEC Release. FINRA Proposed Rule.


Discussion Paper and Request for Comment on Alternative Mortgage Servicing Compensation

On September 27, the FHFA announced that the Joint Initiative on Mortgage Servicing Compensation is seeking comment on two alternative mortgage servicing compensation structures. One proposal would establish a reserve account within the current servicing compensation structure and the other would create a new "fee for service" compensation structure. Comments must be submitted within 90 days of the proposal. FHFA Release. Discussion Paper.


CFTC Final Rule on Non-Narrow-Based Security Index Futures

On September 26, the CFTC adopted Rule 30.13 establishing a certification procedure for the offer or sale to persons in the U.S. of non-narrow-based security index futures contracts traded on foreign boards of trade. The new certification procedure will replace the existing staff no-action process. The final rule will be effective on October 26.  CFTC Final Rule.


SEC Report on NRSROs

On September 30, the SEC issued its annual report, as required under the Dodd-Frank Act, summarizing its findings after examining the practices of credit rating agencies registered with the SEC as NRSROs and subject to SEC oversight. The concerns outlined in the report include, in some instances, apparent failures by NRSROs to: (i) follow rating methodologies and procedures; (ii) make timely and accurate disclosures; (iii) establish effective internal control structures for the rating process; and (iv) adequately manage conflicts of interest. 
SEC Release. SEC Report.


IRS Proposed Rules on Tax Treatment of Swaps

On September 15, pursuant to Section 1601 of the Dodd-Frank Act, the IRS proposed rules amending existing regulations regarding Sections 1256 and 446 of the Internal Revenue Code. The proposed rules provide guidance on the category of swaps and similar agreements that fall within the scope of Section 1256(b)(2)(B) and as a result are excluded from the definition of a Section 1256 contract. The proposed rules also expand the definition of a notional principal contract under Section 446 to include swaps on non-financial indices. Comments must be received by December 15. IRS Proposed Rules.


FINRA Proposed Amendments to NASD Rule 2340

On September 29, FINRA proposed amendments to NASD Rule 2340 to address how firms report the per share estimated values of unlisted Direct Participation Programs and unlisted Real Estate Investment Trusts on customer account statements. Comments must be submitted by November 12. FINRA Notice.


Rating Agency Developments


On September 30, Fitch released its updated criteria for rating trade receivable securitizations. Fitch Release.

On September 28, S&P refined its methodology for its liquidity analysis for determining issuer credit ratings on global corporate issuers. S&P Release.

On September 26, Fitch updated its criteria for analyzing U.S. large loan CMBS. Fitch Release.

On September 23, S&P refined its methodology for assessing the impact of observed interest shortfalls on U.S. RMBS. S&P Release.

On September 19, S&P published its methodology for treatment of the U.S. government as insurer or guarantor, and government agency loan-level support, in structured finance and U.S. public finance transactions. S&P Release.

Note: Free registration is required for S&P and Fitch releases and reports.


Recent Orrick Alerts


SEC Proposes Rule Prohibiting Material Conflicts of Interest in Securitization Transactions

On September 19, the SEC issued proposed Rule 127B, as required under Section 621 of the Dodd-Frank Act, to prohibit material conflicts of interest in connection with certain securitizations. The proposed rule would prohibit certain persons who create and distribute an ABS, including a synthetic ABS, from engaging in transactions within one year after the date of the first closing of the sale of ABS that would involve or result in a material conflict of interest with respect to any investor. Please click here to access the proposed rule. The deadline for comments on the proposed rule is December 19.

Please click here to access our complete update, which includes an overview of the proposed rule and the SEC's proposed interpretive framework regarding application of the proposed rule and its exceptions.


IRS Issues Proposed Regulations Addressing Treatment of Credit Default Swaps and Swap Exclusion Under Section 1256

On September 15, 2011 the Treasury Department issued proposed regulations that would add credit default swaps as well as non-financial indexed derivatives to a revised definition of a notional principal contract. Click here to read more.


Orrick's Distressed Newsletter

Orrick's Distressed Newsletter discusses important developments related to distressed assets. Click here to read the latest edition.


RMBS Litigation


Standard & Poor's Receives "Wells Notice" Regarding CDO Rating

Standard & Poor's parent company, McGraw Hill, disclosed in an 8-K on September 26, 2011 that it had received a "Wells Notice" from the Securities and Exchange Commission regarding the rating of a collateralized debt obligation in August of 2007. The CDO at issue, Delphinus CDO 2007-1, was largely based on subprime mortgage loans. The Wells Notice indicates that the SEC may initiate litigation seeking civil penalties, disgorgement of fees, and other appropriate equitable relief. SEC Filing.


Investor Files Derivative Suit Against Bank of America

On September 26, 2011, a shareholder derivative complaint was filed against Bank of America ("BAC") directors and officers ("Defendants") alleging that they knew about supposedly inadequate review and authorization of foreclosure documents and other activities that exposed BAC to potential liability. Plaintiff alleges that, despite gaining detailed knowledge from extensive due diligence performed prior to BAC's acquisition of Countrywide Financial Corp., Defendants recklessly mismanaged the risks posed by the acquisition and exposed BAC to substantial liability by refusing to cooperate with government regulators investigating BAC's foreclosure practices, obtaining reimbursement on government guaranteed mortgages in violation of the False Claims Act, and other allegedly wrongful acts. Plaintiff alleges violations of Sections 10(b) and 10b-5 of the Exchange Act, breach of fiduciary duty, and breach of the duty of candor. Complaint.


SDNY Dismisses Claims Against Goldman Sachs

On September 28, 2011, Judge Pauley of the Southern District of New York dismissed a suit brought by Ladesbank Baden-Wuerttemberg against Goldman Sachs & Co. and TCW Asset Management alleging common law fraud, negligent misrepresentation, and unjust enrichment in connection with the sale of $37 million in CDO notes collateralized by RMBS. The Court found that Plaintiff's allegations failed to satisfy the heightened pleading standard for fraud claims, and that because the securities were sold pursuant to a purchase agreement, recovery under unjust enrichment was precluded. Additionally, the Court found that Plaintiff's negligent misrepresentation claims failed because information regarding the securities at issue was readily available in public SEC filings. Decision.


Southern District of Ohio Dismisses Suit Against Ratings Agencies

On September 26, 2011, Judge James L. Graham of the United States District Court for the Southern District of Ohio dismissed a lawsuit brought by five Ohio state pension funds against Standard & Poor's Financial Services, LLC, Moody's Investors Service, Inc., and Fitch, Inc., alleging violations of the Ohio Securities Act and negligent misrepresentation. The Ohio pension funds alleged that the credit ratings assigned to certain residential and commercial mortgage-backed securities were false, negligently assigned, based on flawed methodologies, and caused $457 million of losses. The Court, applying both Ohio and New York law to the negligent misrepresentation claim, dismissed all claims. The Court found that Defendants' ratings were non-actionable opinions and, absent specific allegations of fraudulent intent or a duty to the Ohio pension funds, Defendants could not be held liable for alleged negligence in their ratings methodologies. Decision.


Nevada Attorney General and Morgan Stanley Agree to Settlement

On September 27, 2011, Nevada Attorney General Catherine Cortez Masto announced that her office resolved an investigation into Morgan Stanley Mortgage Capital Holdings' ("Morgan Stanley") purchase and securitization of subprime mortgages in the state. The investigation examined whether lenders misrepresented risks to borrowers who took out subprime loans and whether Morgan Stanley was aware of those misrepresentations. Ms. Cortez Masto filed an Assurance of Discontinuance ("Assurance") of the investigation, which requires that Morgan Stanley review all Nevada subprime mortgage loans and confirm that they are in compliance with the Nevada Deceptive Trade Practices Act before financing, purchasing, or securitizing such loans going forward. Morgan Stanley must also adjust interest rates and refund certain interest payments to eligible borrowers and pay $7.2 million to be used to prevent foreclosures and mortgage fraud in Nevada. The Office of the Attorney General estimates the value of the relief as between $21 million and $40 million. Press Release.


FHFA Inspector General Criticizes FHFA's Approval of Freddie's Settlement with BofA

On September 27, 2011, the Office of the Inspector General for the FHFA ("OIG") released a report criticizing the FHFA's approval of Freddie Mac's $1.35 billion settlement of mortgage repurchase claims against Bank of America. The OIG found that significant concerns about the reliability of Freddie's loan review processes should have alerted the FHFA to the risk that these deficiencies skewed its analysis of the risk of loss to Freddie and, therefore, its ability to fairly assess the settlement. OIG Report.




Orrick Breakfast Briefing: SEC Proposal to Prohibit Material Conflicts of Interest in Securitization

On October 7th in our New York office, Orrick lawyers will review the SEC's proposed regulatory framework to prohibit certain conflicts of interest and assess whether the SEC effectively differentiates between legitimate risk mitigation and deceptive practices. We will also consider alternative approaches to manage these conflicts. Click here for more information and to register.


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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