The Financial Report - Volume 3, No. 10 • May 2014 (Global)

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

US Banking Agency and Treasury Department Developments

US Judicial Developments

US Exchanges and Self-Regulatory Organizations

Discussion and Analysis

The demonization of anyone suspected of using technology to analyze market activity and generate securities transactions continues apace. Just as market makers, floor brokers, arbitrageurs, short sellers, creators of mortgage-backed securities and a host of others have had their moments in the sun (or, rather, the interrogation lamp), today all those who loosely fit the definition of “high-frequency traders” are the bad guys of the markets. And while there are any number of persons using high-frequency trading techniques to bad ends, who should be vigorously pursued, regulated and, where appropriate, prosecuted, it is clearly unfair to attack the entire range of market participants using sophisticated analytics and technology as “flash boys.”

Nevertheless, demonizing “Wall Streeters” has long been grist for the entertainment mill, giving rise to sensational magazine articles, books, movies, TV show episodes and, most recently, blogs. But these attacks on the latest Wall Street bad guys rarely offer any insight as to what the world would be like if no one periodically sought to change the ways in which securities are traded, to develop techniques for more efficient and, yes, profitable trading and, dare we say it, to increase the speed at which transactions can be effected. Perhaps there would still be just two-dozen stockbrokers standing under a buttonwood tree.

In a letter to the SEC last year, Senator Markey of Massachusetts said that “[j]ust as we do not allow people to drive a Formula-One race car at 200 MPH on the Massachusetts Turnpike, we should not allow a few Wall Street firms to trade millions of times faster than the average 401K investor on the S&P 500.” But wouldn’t it be equally reasonable to argue against allowing people with no background or training to sit at home trading directly into the markets through an on-line brokerage account by saying “just as we don’t allow an untrained motorist to drive at 12 MPH on the Massachusetts Turnpike, we should not allow untrained amateurs to slow down the markets to pre-1975 levels”? Indeed, isn’t at-home on-line trading a direct result of the development of technology as a tool for investing?

We are, of course, not advocating keeping on-line retail investors out of the markets (although some have wondered from time to time whether those given the facility to trade directly into the marketplace should have to take an exam, just like someone who wants to drive on the Mass Pike has to take a driving test). The point is simply that not every market participant is or ever will be equally skilled or sophisticated, and if we decide to reduce the markets to the lowest (or slowest) common denominator, a lot of very bad things are likely to happen. Would anyone really benefit from throttling the markets down to the speed of “the average 401K investor”?

As one trader said in an article I read recently (paraphrasing as closely as I can from memory), “when I traded on the floor of the exchange, I was faster at processing information and executing trades than many other floor brokers, and there were others who were faster than me. I never considered that the faster brokers should be forced to slow down to my speed, or that all of us should slow down to the speed of the slowest floor broker.”

Or perhaps we should require everyone driving on the Mass Pike to revert to 20 horsepower Model Ts - just to be safe.

News from the Americas

High-speed trading. Bloomberg discussed US Senate Agriculture Committee hearings on high-speed trading. Former CFTC economist Andrei Kirilenko said that new books and records requirements and policy and procedure rules for high-speed traders should be adopted. (5/12/2014) Testimony.

SEC wins insider trading jury verdict. Reuters reported that a jury has found in favor of the SEC in its insider trading lawsuit against Samuel E. Wyly and Charles J. Wyly, Jr. The agency alleges that the Wyly brothers gained more than US$550 million in undisclosed gains while sitting on corporate boards by trading stock in those public companies through hidden entities located in foreign jurisdictions. (5/12/2014) Verdict. See also SEC press release (announcing the lawsuit).

News from Asia and the Pacific

Hong Kong issues crowdfunding reminders. The Hong Kong Securities and Futures Commission issued a notice reminding those engaged in crowd-funding activities of the potential application of certain securities laws and regulations, and reminding the public of the potential risks involved in participating in crowd-funding activities. (5/7/2014) SFC press release.

ASIC reports on red tape reduction. The Australian Securities & Investments Commission released a report outlining ongoing and new initiatives to cut red tape and lower compliance costs for regulated entities. The report outlines ASIC’s recent progress in areas such as financial services licensing and business names registration. The report also highlights the compliance cost savings that result from ASIC’s ongoing work, such as international engagement and waivers and guidance. Comments on the report should be submitted by June 18, 2014. (5/7/2014) ASIC press release.

News from Europe

UK FCA reports on fund charges. The UK Financial Conduct Authority published its findings concerning the marketing information used by 11 fund firms. While a number of good practices were found, the FCA’s review also revealed instances where firms did not present the same summary charges figure on its website and fund documents, did not provide investors with a clear, combined figure for charges in their marketing material or on websites and examples of poor descriptions of administration charges that did not accurately reflect the operation of the charge. (5/13/2014) FCA press release.

UK FCA expectations for dealing commissions. The UK Financial Conduct Authority published a policy paper on how investment managers can use dealing commissions. The paper also clarifies which costs investment managers can pass on to their clients through dealing commissions. (5/8/2014) FCA press release.

ESMA to ease central clearing requirements. The European Securities and Markets Authority advised the European Commission that it will ease certain frontloading requirement under the European Markets Infrastructure Regulation. Frontloading refers to the clearing obligation under EMIR, which will require counterparties to centrally clear certain derivative trades through clearing. (5/8/2014) ESMA notice.

New auditor rules. Business Day noted the UK Financial Reporting Council’s new rule requiring auditors to comment on the risks faced by their audit clients. (5/8/2014) Auditing rules.

EBA consultation on the treatment of equity exposures. The European Banking Authority launched a consultation on draft Regulatory Technical Standards to specify the treatment of equity exposures under the internal ratings-based approach. Comments should be submitted by July 7, 2014. (5/7/2014) EBA press release.

Credit rating agency approved. The European Securities and Markets Authority has approved the registration of EuroRating Sp. z o.o., based in Poland, as a credit rating agency. (5/7/2014) ESMA notice.

EBA publishes risk dashboard. The European Banking Authority published the first risk dashboard for 2014, which summarizes the main risks and vulnerabilities in the banking sector in the European Union. The dashboard includes an annex on aggregate risk parameters. (5/6/2014) EBA press release.

UK FCA guidance on the conversion of asset classes. The Financial Conduct Authority published new guidance on the process of transferring investors from unit classes in existence prior to the implementation of the Retail Distribution Review to those unit classes available now. (5/6/2014) FCA press release.

UK FCA investigatory protocol. The Non-Executive Directors of the Financial Conduct Authority published the protocol setting out the procedures under which the inquiry into the handling of the FCA’s announcement of proposed supervisory work on the fair treatment of long standing customers in life insurance will be carried out. (5/2/2014) FCA press release.

Bank of England Financial Stability Paper. The Bank of England published a paper considering whether and when simpler approaches may outperform more complex methods for modelling and regulating the financial system. (5/2/2014) Financial Stability Paper.

EBA data collection on credit valuation adjustment. The European Banking Authority has launched a data collection exercise to advise the European Commission on appropriate amendments to the European Credit Valuation Adjustment (CVA) framework and inform discussions on the CVA risk charge in Basel. Banks with substantial portfolios of OTC derivatives are encouraged to participate in this data collection exercise on a voluntary basis. (4/30/2014) EBA press release.

UK loses financial tax challenge. The European Court of Justice dismissed a petition brought by the UK which challenged the European Union’s planned financial transaction tax. The Court found that suit was premature because no tax has actually been imposed. (4/30/3014) Court of Justice press release.

Global Regulators

FSB report on reducing reliance on credit ratings. The Financial Stability Board published the final peer review report on national authorities’ implementation of the “FSB Principles for Reducing Reliance on CRA Ratings.” The review found that progress toward the removal of references to CRA ratings from standards, laws and regulation has been uneven. In addition, the key challenge lies in developing alternative standards of creditworthiness and processes so that CRA ratings are not the sole input to credit risk assessment. (5/12/2014) FSB press release.

FSB to collect additional data from G-SIBs. The Financial Stability Board announced the launch of Phase 2 of its Data Gaps initiative to implement a common data template to collect key granular data from global systemically important banks (G-SIBs) about their assets and liabilities. The data will provide authorities with a framework for assessing the interlinkages among the largest banks and the concentration of these institutions to different sectors and markets. The FSB will collect information on G-SIBs’ Institution-to-Institution liabilities, their largest funding providers (banks and non-banks) and their funding structure. (5/6/2014) FSB press release.

Joint Forum reports on point of sale disclosure. The Joint Forum (comprised of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions and the International Association of Insurance Supervisors) released its final report on point of sale disclosure in the insurance, banking and securities sectors. (4/30/2014) Joint Forum press release.

US Securities and Exchange Commission Developments

Regulatory Orders

Conflict minerals rule. The SEC has stayed those parts of Securities Exchange Act Rule 13p-1 and Form SD that require issuers to disclose the “conflict free” status of the materials used in their products. The Commission’s order denied a petition which sought a stay of the entire rule. The Division of Corporation has issued guidance on the conflict minerals disclosure requirements that remain in effect. These rules require firms to file their first Form SDs by June 2, 2014. (5/2/2014)

Selected Enforcement Actions

Software execs settle insider trading charges. The SEC filed settled insider trading charges against three software company founders for taking unfair advantage of incorrect media speculation and analyst reports about the company’s acquisition. The SEC alleged that Lawson Software’s co-chairman Herbert Richard Lawson tipped his brother William Lawson and family friend John Cerullo with nonpublic information about the status of the company’s 2011 merger discussions with a privately-held software provider. Lawson Software’s stock price had begun to climb following media and analyst reports that multiple bidders were possible. However, Richard Lawson knew that such reports were incorrect, and that the merger price offered by the lone bidder was significantly lower than what journalists and analysts were speculating. While in possession of the accurate, inside information from his brother, William Lawson sold more than one million shares of his family’s Lawson Software stock holdings. He also tipped Cerullo, who sold approximately 175,000 of the company’s shares on the basis of the nonpublic information. The Lawsons and Cerullo agree to settle the matter without admitting or denying the SEC’s allegations. (5/12/2014) SEC press release.

SEC alleges investment advisor hid custodial account shortfall. The SEC announced the filing of a contested lawsuit against Professional Investment Management (PIM), an investment advisory firm, and its president, Douglas Cowgill, for hiding a shortfall of more than US$700,000 in client assets. The SEC commenced an examination of the firm in November 2013 after learning that, for four consecutive years, PIM had failed to arrange for independent verification of client assets as required by the SEC’s Custody Rule, and had filed a notice withdrawing its registration with the SEC. The examination sought to verify PIM’s client statements which showed that a particular money market fund held US$7.7 million while the SEC alleges the account only held US$7 million, a fact which Cowgill tried to conceal by entering fake trades. (5/5/2014) SEC press release.

Other Developments

Commissioner Gallagher discusses investment advisors. Commissioner Daniel M. Gallagher suggested the use of third-parties to examine investment advisors, in order to help balance the lack of information the SEC has concerning them when compared to what it knows about brokers. The use of third parties, including a self-regulatory organization, would also provide information concerning whether the fiduciary duty owed by brokers and investment advisors should be harmonized. (5/9/2014) Gallagher speech.

Commissioner Stein comments on disclosure. Improvements that could be made to the SEC’s issuer disclosure requirements were the subject of a recent speech made by SEC Commissioner Kara M. Stein. Stein called for fuller, more useable, and more timely disclosure. (5/8/2014) Stein speech.

Investor alert. The SEC issued an advisory to investors concerning the risks related to virtual currencies. (5/7/2014) Investor alert.

Private equity compliance. The SEC’s Director of the Office of Compliance Inspections and Examinations, Andrew J. Bowden, discussed private equity fund compliance. Staff examiners of private equity managers have identified violations of law or material control weaknesses concerning fees and expenses over 50 percent of the time. (5/6/2014) Bowden speech.

Chair White testifies before Congress. Testifying before the House Financial Services Committee, SEC Chair Mary Jo White discussed the SEC’s focus, noting that she expects more settlements in which respondents will be required to admit responsibility. White further stated that the Enforcement Division will be expanding its efforts in the areas of financial reporting, issuer reporting, and audit failures. (4/29/2014) White testimony.

Commissioners comment on well-known seasoned issuers. SEC Commissioner Daniel Gallagher commented on the Division of Corporation Finance’s April 24, 2014 “Revised Statement on Well-Known Seasoned Issuer Waivers,” which outlines how the Division will assess the merits of well-known seasoned issuer (WKSI) waiver applications. Gallagher contends that disqualification is justified (and waivers should be denied), when the issuer’s financial reporting cannot be trusted. (4/29/2014) Gallagher statement. Previously, SEC Commissioner Kara Stein dissented to the Commission’s April 25, 2014 order granting a WKSI ineligibility waiver to The Royal Bank of Scotland after one of the bank’s subsidiaries pleaded guilty to having manipulated the London interbank offered rate. In that dissent Stein asked whether the SEC had decided “that some firms are just too big to bar.” (4/28/2014)

US Commodity Futures Trading Commission Developments

Global Markets Advisory Committee to meet. The CFTC Global Markets Advisory Committee will meet on May 21, 2014 to discuss issues related to the CFTC’s coordination with foreign regulators on the oversight of foreign-based swap clearinghouses and foreign swaps execution facilities. (5/9/2014) CFTC press release.

Streamlined application process for CPO registration relief. The Division of Swap Dealer and Intermediary Oversight announced a streamlined approach for considering requests for registration no-action relief on an expedited basis from commodity pool operators (CPO) who delegate certain activities to a registered CPO. (5/12/2014) CFTC press release.

Temporary SEF approved. The CFTC approved the application of ICAP Global Derivatives Limited for temporary registration as a swap execution facility. (5/9/2014) CFTC press release.

DCO registration relief. The Division of Clearing and Risk granted OTC Clearing Hong Kong Limited time-limited relief from the requirements to register as a derivatives clearing organization. (5/7/2014) CFTC press release.

CFTC Expands Electronic Filing Capabilities. New enhancements to the CFTC’s filing portal have been made. The portal has been expanded to allow designated contract markets, swap execution facilities and swap data repositories to electronically submit event-specific reports to the CFTC. (5/5/2014) CFTC press release.

Packaged trades implementation timeline. Beginning May 16, 2014, market participants executing swaps that are part of a “package transaction” (that is, transactions which include at least one swap that has been made available to trade), must do so on a swap execution facility or designated contract market in accordance with a phased compliance timeline. (5/1/2014) CFTC Press Release.

Interposed longevity reinsurance transactions. The CFTC has made public the Division of Swap Dealer and Intermediary Oversight’s no-action letter, which granted an insurance company’s request to be allowed to provide reinsurance of pension plans’ longevity risks through multi-step “Interposed Longevity Reinsurance Transactions” without such reinsurance being considered as insurance or a guarantee of a swap. CFTC Letter No. 14-67.

CPO relief. In the following letters, the CFTC has provided commodity pool operators with relief from rules requiring the submission of independently audited financial statements: CFTC Letter No. 14-63; CFTC Letter No. 14-64; CFTC Letter No. 14-65; CFTC Letter No. 14-66.

US Banking Agency and Treasury Department Developments

Merger limits proposed. In accordance with Section 622 of the Dodd-Frank Act, the Federal Reserve Board issued a proposed rule which would prohibit a financial company from combining with another company if the ratio of the resulting financial company’s liabilities would exceed 10 percent of the aggregate consolidated liabilities of all financial companies. Comments should be submitted by July 8, 2014. (5/8/2014) Federal Reserve Board press release.

FSOC annual report. The Financial Stability Oversight Council published its 2014 annual report to Congress. The report noted the continued risks posed by weaknesses in the short-term wholesale funding markets and the moral hazard posed by large, interconnected financial institutions. (5/7/2014) Treasury Department Press Release.

US Judicial Developments

Summary judgment was properly entered in whistleblower suit. The former president of a company claimed that he was unlawfully terminated from his employment in retaliation for having engaged in protected activity under the Sarbanes-Oxley Act. Affirming the entry of summary judgment dismissing the suit, the US Court of Appeals for the Fourth Circuit held that plaintiff failed to establish by a preponderance of the evidence that his alleged protected activities were a contributing factor to his termination. (5/12/2014) Feldman v. Law Enforcement Associates Corporation.

Lifetime industry ban is affirmed. The US Court of Appeals for the Seventh Circuit affirmed the SEC’s order barring Carl Birkelbach for life from the securities industry for supervisory failures. Although the supervisory failures began more than five years before the Financial Industry Regulatory Authority initiated the proceedings, the matter was not barred by the statute of limitations. Where, as here, there is an ongoing series of failures to supervise those failures are divisible even if there was additional untimely violative conduct. In addition, the court found that the egregious nature of Birkelbach’s failures supported the SEC’s order affirming the decision to ban Birkelbach. (5/2/2014) Birkelbach v. SEC.

US Exchanges and Self-Regulatory Organizations

FINRA revises codes for reporting customer complaints. Beginning October 1, 2014, firms must select revised and new product and problem codes when reporting to the Financial Industry Regulatory Authority information regarding written customer complaints alleging theft or misappropriation of funds or securities, or forgery; in quarterly statistical and summary information regarding written customer complaints; and when completing the online form to file copies of required documents. (5/7/2014) FINRA Regulatory Notice 14-20.

Revised BrokerCheck hyperlink proposal. The Financial Industry Regulatory Authority is requesting comment on a revised proposal to require a hyperlink to BrokerCheck in firms’ online retail communications with the public. Comments should be submitted by June 16, 2014. (4/30/2014) FINRA Regulatory Notice 14-19.

FINRA Revises Series 26 Exam Program. The Financial Industry Regulatory Authority has revised the Investment Company and Variable Contracts Products Principal (Series 26) examination program. The changes will appear in Series 26 examinations administered on or after June 16, 2014. (4/30/2014) FINRA Regulatory Notice 14-18.

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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