The Financial Report - Volume 2, No. 17 • September 2013

by DLA Piper


Discussion and Analysis

News from the Americas

News from Asia and the Pacific

News from Europe

Global Regulators

US Securities and Exchange Commission Developments

US Commodity Futures Trading Commission Developments

Discussion and Analysis

Even some financial services industry professionals are confused. The 80-year-old prohibition on general solicitation ended on Monday of last week. This means it is now legal for companies to solicit certain qualified investors and to advertise that they are seeking to raise capital. This change was mandated under Title II of the JOBS Act.

The rules for crowdfunding, the ability of ordinary or “retail investors” to make small investments in, typically, startup businesses, have not yet been adopted, or even proposed, however. In fact, the mandate for crowdfunding is created by a different section, Title III of the JOBS Act, than the lifting of the ban on general solicitation.

It is possible that the confusion was caused by vocal supporters of crowdfunding, many of whom have grown impatient waiting for the SEC to propose and adopt rules for this potential new market. The JOBS Act had set the end of last year as the deadline for final rules on crowdfunding, a deadline which clearly has been missed.

So, at this point, the “crowd” is somewhat smaller than many would like. Currently, only “accredited investors” can purchase securities pursuant to a general solicitation. As a result, companies formed as equity crowdfunding platforms are either sitting idle while awaiting the approval of the crowdfunding rules, or are trying to turn themselves into platforms to facilitate private placements engaging in a general solicitation to lure accredited investors.

In his Monday post at Reuters, the finance blogger Felix Salmon writes, “The idiocy of crowds”: “It is conceivable that over time, these equity crowdfunding platforms will learn from their inevitable mistakes, and the few which survive will learn how to be something other than a hole in which to pour millions of dollars.” The name of his post, by the way, is “The idiocy of crowds.” Mr. Salmon’s thesis, essentially, is that startups, and platforms for startup companies, will probably end up breaking the law. This is because, by definition, those startups seeking crowdfunding generally already have failed in their efforts to raise money through more conventional avenues. Unless crowdfunding or private placement platforms can perform sufficient due diligence on both the startups and the potential investors, something that would seem to be impossible in the social-media driven Internet era, those platforms will be assuming all of the risks attendant to linking unsophisticated investors together with startups that have already been passed over by experienced investors.

If Mr. Salmon’s thesis is correct, it will be interesting to see whether these platforms first survive long enough for the crowdfunding rules to be adopted, and, thereafter, whether they can create a business model which avoids the seemingly inevitable risk that, eventually, people will fund businesses, the business will fail and the investors will be peeved.

News from the Americas

Federal regulators issue guidance on financial abuse of older adults. The Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, Federal Trade Commission, National Credit Union Administration, Office of Comptroller of the Currency, and Securities and Exchange Commission have issued interagency guidance clarifying the applicability of the Gramm-Leach-Bliley Act’s privacy provisions to reporting suspected financial exploitation of older adults. Noting recent studies suggesting that financial exploitation is the most common form of elder abuse, and that only a small fraction of incidents are reported, the agencies believe that prompt reporting of suspected exploitation to adult protective services, law enforcement, and/or long-term care ombudsmen can result in appropriate intervention, prevention of financial loss, and other remedies. (9/24/2013)

Canada’s OSC to hold roundtable concerning women on boards. The Ontario Securities Commission will host a roundtable on October 16, 2013, to explore the issues identified in OSC Staff Consultation Paper 58-401 Disclosure Requirements Regarding Women on Boards and in Senior Management, including effective policies and practices and disclosure requirements regarding women on boards and in senior management. (9/23/2013) OSC press release.

Canadian Ministers of Finance agree to form cooperative regulatory system. The Ministers of Finance of British Columbia, Ontario and Canada have agreed to establish a cooperative capital markets regulatory system. All provinces and territories are invited to participate in the proposed system. The single cooperative securities regulator will administer a single set of regulations and be operationally independent and self-funded through a single set of fees. It will be directed by a board of independent directors, and a Council of Ministers of all participating jurisdictions will oversee the cooperative system. The new regulator will have an executive head office in Toronto and a nationally integrated executive management team. (9/19/2013) Department of Finance Canada press release.

Canadian Securities Administrators issue proxy advisory update. The Canadian Securities Administrators published an update concerning its consultation on proxy advisory firms. The CSA has concluded that a policy-based approach providing guidance on recommended practices and disclosure for proxy advisory firms will improve transparency and understanding among market participants. (9/19/2013) CSA press release.

OSC guidance on mortgage investment entities and investment funds. The Ontario Securities Commission published the factors it will consider when determining whether an issuer that proposes to invest all or substantially all of its assets in a pool of mortgages is an investment fund. (9/12/2013) OSC staff notice.

News from Asia and the Pacific

Asia Region Funds Passport announced. The Monetary Authority of Singapore announced that the Finance Ministers of Singapore, Australia, Korea and New Zealand signed a Statement of Intent in Bali, Indonesia, to jointly develop the Asia Region Funds Passport (ARFP), which will facilitate the cross-border offering of funds in Asia. The ARFP will offer fund managers operating in a passport economy a direct and efficient route to distribute their funds in other passport economies. (9/20/2013). MAS press release.

ASIC proposed guidance for SMSF advice. The Australian Securities & Investments Commission published proposed guidance on the advice that the self-managed superannuation fund sector provides to investors. Comments should be submitted by November 11, 2013. (9/16/2013) ASIC press release.

News from Europe

ESMA reports on market conditions. The European Securities and Markets Authority published its “Trends, Risks, Vulnerabilities (TRV) Report” and a Risk Dashboard for the second quarter of 2013. The TRV examines the performance of securities markets in the first half of 2013, assessing both trends and risks in order to develop a comprehensive picture of systemic and macro-prudential risks in the EU and to assist both national and EU bodies in their risk assessments. (9/20/2013) ESMA notice.

ECB to introduce ABS loan-level reporting requirements. The European Central Bank announced that it will introduce loan-level reporting requirements for asset-backed securities backed by credit-card receivables, when these are used as collateral in the Eurosystem’s monetary policy operations. (9/19/2013) ECB press release.

UK pension reforms announced. The UK’s Office of Fair Trading announced reforms to the market for defined contribution workplace pensions. (9/19/2013) OFT press release.

FCA releases Retail Distribution Review; proposes guidance. The UK Financial Conduct Authority published a review which found that life insurance and advisory firms may be influenced by inducements from product providers, undermining the Retail Distribution Review. (9/17/2013) FCA RDR press release. In connection with that review, the FCA published proposed guidance to firms on appropriate practices when providing investment advice. Comments should be submitted by October 18, 2013. (9/17/2013) FCA guidance press release.

Updated EMIR timetable for trade reporting. The European Securities and Markets Authority published an updated version of its European Market Infrastructure Regulation implementation timetable. The registration of the first trade repositories is not expected before November 7, 2013. As a result, reporting to trade repositories is not expected to start before February 2014. (9/13/2013) ESMA notice.

UK FCA statement on physically settled gas and power forwards. The UK’s Financial Conduct Authority issued a statement concerning broker-operated systems trading physically settled gas and power forwards. (9/11/2013)

Global Regulators

IOSCO and IFRS Foundation join to implement IFRS. The International Organization of Securities Commissions and the IFRS Foundation announced that they have agreed on a set of protocols under which the two organizations will deepen their cooperation in both the development of IFRS and implementation of IFRS on a globally consistent basis. (9/18/2013) IOSCO press release.

Regulatory reforms and emerging economies. The Financial Stability Board provided an update on the study it is conducting, in collaboration with the International Monetary Fund and the World Bank, regarding the possible unintended consequences of regulatory reforms on emerging markets and developing economies. (9/12/2013)

US Securities and Exchange Commission Developments

New Final Rules

Municipal advisor registration. The SEC adopted new final rules for the permanent registration of municipal advisors. Under the new rule, a municipal advisor must register with the SEC if it provides advice on the issuance of municipal securities or about certain “investment strategies” or municipal derivatives. The final rule narrows the application of the term “investment strategies” to apply only to the investment of proceeds from the sale of municipal securities rather than to all public funds. Activities-based exemptions are also included. The new rule will be effective 60 days after publication in the Federal Register, which is expected shortly. (9/18/2013) SEC press release. In conjunction with the adoption of the new registration rules, the SEC extended to December 31, 2014, its existing interim final temporary Rule 15Ba2-T, which provides for the temporary registration of municipal advisors under the Securities Exchange Act of 1934. (9/23/2013) SEC Release No. 34-70468.

Proposed Rules

Pay ratio disclosure rules. The SEC proposed new rules that would require public companies to disclose the ratio of the compensation of its CEO to the median compensation of its employees. The proposal does not include a specific methodology for calculating the ratio; instead, a company may choose an appropriate methodology, including one using statistical sampling and estimates. Comments should be submitted within 60 days after publication in the Federal Register, which is expected shortly. (9/18/2013) SEC press release.

Selected Enforcement Actions

Hedge Fund Advisor settles conflict of interest charges. The SEC charged Shadron L. Stastney, the adviser to a New York-based hedge fund, with breaching his fiduciary duty by engineering an undisclosed principal transaction in which he had a financial conflict of interest. Without admitting or denying the allegations, Stastney agreed to pay more than US$2.9 million to settle the SEC’s charges. (9/18/2013) SEC press release.

SEC issues risk alert regarding short selling rules. The SEC’s Office of Compliance Inspections and Examinations has issued a risk alert to highlight compliance with Rule 105, which generally prohibits purchasing securities in follow-on and secondary offerings when the purchaser has effected short sales in the securities within a specified amount of time prior to the pricing of the offering. The risk alert highlights observations by SEC examiners and corrective actions that firms have taken to address Rule 105 concerns. (9/17/2013)

Investment adviser settles conflicts of interest allegations. The SEC instituted settled administrative proceedings against investment adviser Sarkauskas and Associates, Inc. and James M. Sarkauskas, its principal. Without admitting or denying the allegations, respondents consented to the entry of an order finding that they violated the Investment Advisers Act when they purchased unit investment trust (UIT) units bearing transactional sales charges in their clients’ accounts without disclosing that identical UIT units sold at net asset value with no transactional sales charges were available for purchase and that the adviser’s purchases of the units bearing transactional sales charges substantially increased the respondents’ compensation, thereby creating a conflict of interest. To settle the allegations the adviser agreed to pay disgorgement of US$331,433.98, and prejudgment interest of US$18,403.22. Sarkauskas will pay a civil penalty of US$100,000 and has agreed to an industry bar. (9/13/2013) In the Matter of Sarkauskas and Associates, Inc., SEC Release No. 34-70338.

Other Developments

Investment Management Division director speaks at hedge fund conference. At a recent Practicing Law Institute conference, Norm Champ, SEC Director, Division of Investment Management, spoke on the SEC’s new general solicitation and “bad actor” rules, regulatory initiatives affecting the hedge fund industry and the importance of a robust culture of compliance. (9/12/2013) Champ speech.

US Commodity Futures Trading Commission Developments

Regulatory Orders

LCH.Clearnet receives time-limited no-action relief. The CFTC’s Division of Clearing and Risk announced that it will not recommend enforcement action against LCH.Clearnet Ltd for clearing certain swaps (DCM/SEF Swaps) executed on, or subject to the rules of, designated contract markets or swap execution facilities, and will not recommend enforcement action against LCH’s clearing members for clearing DCM/SEF Swaps through LCH. This relief will be effective until the earlier of March 31, 2014, or the date on which the CFTC approves or denies LCH’s application for an amended DCO registration order to permit it to clear DCM/SEF Swaps. (9/23/2013) CFTC press release.

Futures contracts deemed certified. The CFTC’s Division of Market Oversight has deemed certified: (1) the BSE S&P BSE 100 Index futures contract, (9/24/2013); (2) the Hong Kong Futures Exchange Limited’s CES China 120 Index futures contract and HSI Volatility Index futures contract, (9/17/2013); and (3) the Euronext Amsterdam AEX-Index mini futures contract and the Euronext Paris CAC40 Index mini futures contract. (9/13/2013)

Temporary SEFs approved. The CFTC has approved the following applications for temporary registration as swap execution facilities: SwapEx, LLC, GFI Swaps Exchange LLC, and MarketAxess SEF Corporation, (9/13/2013); TeraExchange, LLC, (9/18/2013); Javelin SEF, LLC and BGC Derivative Markets, L.P., (9/19/2013); trueEX, LLC and ICE Swap Trade, LLC (9/20/2013); and 360 Trading Networks Inc. (9/23/2013).

Requests for Comment

Exchange for Related Position Transaction rules. The CFTC seeks comments on a request from the Chicago Mercantile Exchange, the Chicago Board of Trade, the New York Mercantile Exchange, the Commodity Exchange and the Board of Trade of Kansas City, Missouri for approval of amendments to existing Rule 538 of the Exchanges’ rulebooks and the issuance of CME Group Market Regulation Advisory Notice RA1311-5. The Exchanges seek to eliminate the use of transitory Exchange for Related Positions transactions (EFRP) wherein the execution of an EFRP is contingent upon the execution of another EFRP or related position transaction between the parties and where the transactions result in the offset of the related positions without the incurrence of market risk in the context of the related position transactions. Comments should be submitted by October 18, 2013. (9/17/2013) CFTC press release.

Other Developments

Chairman Gensler comments on substituted compliance. Comments made by CFTC Chairman Gary Gensler were summarized by Gensler told an industry conference that he expects the CFTC to have a first round of substituted compliance determinations for swap entities completed by December 21, 2013. (9/19/2013) Substituted compliance.

US Banking and Treasury Developments

Non-bank SIFI named. The Financial Stability Oversight Council voted to designate Prudential Financial Inc. as a non-bank systemically important financial institution. (9/20/2013) FSOC press release.

Interim capital requirements. The FDIC published interim final rules revising its risk-based and leverage capital requirements for FDIC-supervised institutions. The interim final rule consolidates three separate notices of proposed rulemaking jointly published with other banking regulators on August 30, 2012, with selected changes. The interim final rule implements a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, a higher minimum tier 1 capital requirement, and, for FDIC-supervised institutions subject to the advanced approaches risk-based capital rules, a supplementary leverage ratio that incorporates a broader set of exposures in the denominator. The interim final rule is effective January 1, 2014. Comments should be submitted by November 12, 2013. (9/10/2013) 78 FR 55339.

US Judicial Developments

Second Circuit affirms dismissal of claims of aiding and abetting commodity market manipulation. In a case in which certain plaintiffs alleged that a clearing broker aided and abetted the manipulation of natural gas prices by a hedge fund for which it provided clearing and execution services, the Second Circuit held that the plaintiffs failed to state a claim that the clearing broker knowingly and intentionally aided and abetted any manipulation, and therefore affirmed a district court’s dismissal of the plaintiffs’ complaint and amended complaint. (9/23/2013) In re Amaranth Natural Gas Commodities Litigation.

Loss causation. The US Court of Appeals for the Ninth Circuit affirmed the entry of summary judgment dismissing Securities Exchange Act Section 10(b)(5) claims for failure to establish a triable issue of fact concerning loss causation. The Court found that the plaintiffs’ claim that they would not have purchased the bonds but for the City’s alleged misrepresentation of the risks only addressed reliance. The plaintiffs failed to link the claimed misrepresentations to the economic loss suffered. The Court further noted that the fact that the bonds were traded on an inefficient market did not change the requirement to show loss causation. (9/19/2013) Nuveen Municipal High Income Opportunity Fund v. City of Alameda, California.

SLUSA preempts Madoff feeder fund claims. The dismissal of state law claims for allegedly aiding and abetting Bernie Madoff’s Ponzi scheme was affirmed by the US Court of Appeals for the Second Circuit. Although the investors had placed their funds in foreign investment vehicles, which in turn invested with Madoff, the Court held that the Securities Litigation Uniform Standards Act (SLUSA) applied because the claims were predicated on defendants’ involvement with Madoff’s fraudulent securities transactions. The Court further found that the fact Madoff may not have actually executed any securities trades did not take the case outside of SLUSA. (9/16/2013) Trezziova v. Kohn.

US Exchanges and Self-Regulatory Organizations

SEC approves amendments to FINRA customer arbitration rules. The Financial Industry Regulatory Authority announced that the SEC approved amendments to FINRA Rule 12403 of the Code of Arbitration Procedure for Customer Disputes to simplify the arbitration panel selection process in cases with three arbitrators. (9/23/2013) FINRA Regulatory Notice 13-30.

FINRA revises membership proposal. The Financial Industry Regulatory Authority requested comment on a revised proposal to transfer the NASD Rule 1010 Series (Membership Proceedings), with substantive changes, into the Consolidated FINRA Rulebook as the FINRA Rule 1100 Series (Member Application). The proposal includes additional rule provisions to address regulatory issues identified by FINRA staff and codify existing membership-related interpretations and practices. Comments should be submitted by November 4, 2013. (9/20/2013) FINRA Regulatory Notice 13-29.

FINRA broker compensation proposal. The Financial Industry Regulatory Authority will submit to the SEC a proposal that would require brokers to disclose recruitment compensation paid to them as an incentive to move to a new firm. The disclosure requirement would apply to recruitment compensation of US$100,000 or more, and to future payments contingent on performance criteria. (9/19/2013) FINRA press release.

FINRA to conduct cost-benefit analysis. The Financial Industry Regulatory Authority issued a statement explaining the analysis it will apply to rule proposals. (9/19/2013) FINRA press release.

FINRA issues investor alert. The Financial Industry Regulatory Authority warned investors on the risks to be considered when investing in a private placement. (9/17/2013) FINRA press release.

NFA recordkeeping requirements. The National Futures Association reminded members of CFTC reporting requirements which become effective December 21, 2013. (9/16/2013) NFA Notice I-13-25.

NFA CTA quarterly filing requirements. The National Futures Association announced that it will begin the new quarterly filing requirement applicable to all commodity trading advisors that are registered with the Commodity Futures Trading Commission and members of the NFA for the quarter ended September 30, 2013. As a result, the first quarterly filing requirement for CTAs on NFA Form PR will be due on November 14, 2013 (i.e., 45 days after the quarter ended September 30, 2013). CTAs are already subject to a similar CFTC reporting requirement on an annual basis on CFTC Form CTA-PR, which is required to be filed within 45 days of the end of each calendar year. The required NFA Form PR filing for a quarter ended December 31 will also satisfy the CFTC requirement. Both NFA Form PR and CFTC Form CTA-PR applicable to CTAs are submitted online through the NFA’s EasyFile system. Because NFA Form PR consists of the information requested on CFTC Form CTA-PR plus additional information, CTAs should review NFA Form PR now in order to prepare for the upcoming deadline. Sample NFA Form PR templates are available on the NFA’s website. (9/16/2013) NFA Notice I-13-24. Form PR Template (NFA Members); Form PR Template (Non-NFA Members).


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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